October 2000
E.B. 2000-14
INCOME TAX MANAGEMENT
AND REPORTING FOR
SMALL BUSINESSES AND FARMS
2000 Reference Manual for Regional Schools
Charles H. Cuykendall
Gregory J. Bouchard
Agricultural Finance and Management at Cornell
Cornell Program on Agricultural and Small Business Finance
Department of Agricultural, Resource, & Managerial Economics
College of Agriculture and Life Sciences, Cornell University, Ithaca, NY 14853-7801
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Publication Price Per Copy: $15.00
For additional copies, contact:
Carol Fisher
Department of Agricultural, Resource, and
Managerial Economics
Agricultural Finance and Management at Cornell
357 Warren Hall
Cornell University
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Fax:
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Phone: 607-255-1585
TABLE OF CONTENTS
Page
2000 TAX FORMS NEEDED BY NEW YORK FARMERS....................................................................................i
2000 TAX LEGISLATION AND FARM INCOME SITUATION........................................................................... 1
FEDERAL TAX PROVISIONS AFFECTING INDIVIDUALS .............................................................................. 2
LONG TERM CAPITAL GAINS RATES .............................................................................................................. 13
SALE OF TAXPAYERS PRINCIPAL RESIDENCE............................................................................................. 16
INCOME AVERAGING FOR FARMERS ............................................................................................................. 17
CCC COMMODITY LOANS AND LOAN DEFICIENCY PAYMENTS…......................................................... 22
PROVISIONS APPLYING PRIMARILY TO BUSINESS ACTIVITY................................................................. 24
CORPORATE AND PARTNERSHIP PROVISIONS ............................................................................................ 27
INCOME TAX IMPLICATIONS OF CONSERVATION AND ENVIRONMENTAL PAYMENTS
AND GRANTS RECEIVED BY FARMERS ........................................................................................................ 28
INCOME FROM CANCELLATION OF DEBT AND RECAPTURE AGREEMENTS....................................... 30
LIKE-KIND TAX FREE (Deferred) EXCHANGES .............................................................................................. 31
DEPRECIATION AND COST RECOVERY ......................................................................................................... 33
GENERAL BUSINESS CREDIT............................................................................................................................ 42
A REVIEW OF FARM BUSINESS PROPERTY SALES...................................................................................... 44
INSTALLMENT SALES......................................................................................................................................... 49
LEASING OF LAND AND OTHER FARM ASSETS........................................................................................... 52
ALTERNATIVE MINIMUM TAX (AMT) ........................................................................................................... 55
INFORMATIONAL RETURNS ............................................................................................................................. 58
SOCIAL SECURITY TAX AND MANAGEMENT SITUATION, AND OTHER PAYROLL TAXES.............. 60
NEW YORK STATE INCOME TAX ..................................................................................................................... 65
2000 TAX FORMS NEEDED BY MANY NEW YORK FARMERS
Federal Forms
1040
- U.S. Individual Income Tax Return
Schedule A & B - Itemized Deductions and Interest and Dividend Income (no Capital Gains)
Schedule D - Capital Gains and Losses
Schedule E - Supplemental Income and Loss
Schedule EIC - Earned Income Credit
Schedule F - Profit and Loss from Farming
Schedule H - Household Employment Taxes
Schedule J – Farm Income Averaging
Schedule R - Credit for the Elderly or the Disabled
Schedule SE - Self-employment Tax, (short and long schedules)
1040A - Nonitemizers, under $50,000 taxable income, other limitations
1040X - Amended U.S. Individual Income Tax Return
943
- Employer's Annual Tax Return for Agricultural Employees
1099's - Information returns to be filed by person who makes certain payments
1096
- Annual Summary and Transmittal of U.S. Information Returns
W-2
- Wage and Tax Statement; W-3 - Transmittal of Income and Tax Statement
W-5
- Earned Income Credit Advance Payment Certificate
W-9
- Request for Taxpayer Identification Number: used to provide TIN to individual filing 1099
(use SS-4 to obtain employer ID)
1065
- U.S. Partnership Return of Income (see rules for Sch. L, M-1 and M-2.)
3115
- Application for Change in Accounting Method
3800
- General Business Credit
4136
- Credit for Federal Tax on Fuels
4562
- Depreciation and Amortization: used to report depreciation, cost recovery, Section 179
expense election, and listed property.
4684
- Casualties and Thefts
4797
- Sales of Business Property
4835
- Farm Rental Income and Expense [Crop and Livestock Shares (not cash) Received by
Landowner]
6251
- Alternative Minimum Tax Computation - Individuals
6252
- Installment Sale Income
8582
- Passive Activity Loss Limitations
8582-CR-Passive Activity Credit Limitations
8606
- ondeductible IRA Contributions, IRA Basis, and Nontaxable IRA Distributions
8615
-Tax for Children Under Age 14 Who Have Investment Income of More Than $1,300
8801
-Credit for Prior Year Minimum Tax -- Individuals and Fiduciaries
8812
-Additional Child Tax Credit
8824
-Like-Kind Exchanges
8829
-Expenses for Business Use of Your Home
8863
-Education Credits
New York State Forms
IT-201
- Resident Income Tax Return (long form)
IT-201-ATT - Summary of Other Credits and Taxes
IT-201-X
- Amended Resident Income Tax Return (only acceptable method)
IT-204
- Partnership Return
IT-212
- Investment Credit (recapture or early disposition schedule included)
IT-215
- Earned Income Credit
IT-217
- Claim for Farmers School Tax Credit (for individuals, estates and trusts)
IT-220
- Minimum Income Tax
IT-399
- New York State Depreciation Schedule (with instructions)
CT-4-S
- Short Form for S Corporations
CT-47
- Claim for Farmers School Tax Credit (for corporations)
NYS-45
- Quarterly Combined Withholding and Wage Reporting Return and Unemployment Ins.
NYS-45-AT - Quarterly Combined Withholding and Wage Reporting Return and Unemployment Ins.
i
2000 TAX LEGISLATION AND FARM INCOME SITUATION*
What’s New in Federal Legislation
•
Beginning with 2000, taxpayers may use Form 1040A rather than 1040, if they have capital gain
distributions from a mutual fund that are subject to the 20% maximum rate and meet all other
requirements for use of this form. There may be a conflicting statement on the instructions to the Form
1099-DIV. The caution in the instruction for copy B of 1099 DIV states the amount in box 2a (capital
gain distributions) must be reported on Form 1040 and may not file 1040A. The new development
supercedes the caution statement.
•
There is a new additional definition of eligible foster child that includes “has been placed with you by an
authorized placement agency.”
•
To make the income averaging election Treasury Regulation Sec 301 gives the taxpayer an automatic
six-month extension, if a timely income tax return was filed for the tax year.
•
Extension of certain general business credits and tax-free status of employer-provided educational
assistance.
•
An organization that lends money as a significant part of its trade or business must issue a Form 1099-C
reporting any cancelled debt.
•
To avoid an estimated tax penalty, taxpayers with AGIs in excess of $150,000 ($75,000 married filing
separately) will have to deposit the smaller of 90% of expected tax for 2000 or 108.6% of the tax shown
on your 1999 return. Estimated tax may now be paid by credit card.
•
Reminder: Those taxpayers whose only capital gain distributions were from a mutual fund generally do
not have to file schedule D, but rather just include that amount on line 13 of 1040 and check a box.
•
IRS computers, in error again, rejected many schedule J calculations and Earned Income Credits from
farm returns. One can just call the 800 number to rectify this error.
2000 Farm Income Tax Situation
New York farm gate milk prices received will be down in 2000, compared to 1999. The drop of
approximately $2.00 per hundredweight during the year 2000 and continued record quantities of milk
produced will provide additional pressure on farm milk price for at least another year. Those well-managed
farms with positive net earnings will want to consider year-end tax management in light of the continued
downward pressure on milk price. Other farmers will want to accelerate income to utilize their exemptions
and deductions because the high petroleum price caused skyrocketing nitrogen, fuel and heating expenses.
The 2000 net farm incomes of cash crop, fruit and vegetable producers will vary widely. Heavy rains
and cool weather throughout the summer have increased disease pressure and slowed development for some
crops. Early summer hailstorms and one August hailstorm devastated some orchards in the Hudson Valley.
Grape and apple production for the state are expected to be near the five-year average production, but
utilization of the apple crop will somewhat lower due to hail damage. New York processing vegetable
acreage was down.
* This manual was written by Charles H. Cuykendall, Senior Extension Associate, Agricultural Finance
and Management, Department of Agricultural, Resource, and Managerial Economics, Cornell University
and Gregory J. Bouchard, Manager, Farm Credit of WNY Tax Service, Phelps, New York.
1
Tax management suggestions for farmers with 2000 net farm profits:
•
Purchase quantities of feed and supplies before the year-end. These prepaid expenses may be claimed if
they do not exceed 50% of other expenses on Sch. F.
•
Buy needed machinery now. Take advantage of the Sec. 179 deduction as well as rapid depreciation.
•
Pay additional wages to family members who actually work on the farm. Consider paying Christmas
bonuses to regular employees.
•
Purchase IRAs or other tax deferred retirement plans.
FEDERAL TAX PROVISIONS AFFECTING INDIVIDUALS
Standard Deduction
The standard deduction is indexed to inflation and is adjusted annually. The 2000 standard
deduction is about 2.0% higher than the 1999 standard deduction. Due to the inflationary adjustment the
deduction for 2001 will be around 3.0% higher.
Basic Federal Standard Deduction for 1997, 1998, 1999, 2000 and 2001
Filing Status
Married filing jointly; or qualifying widow(er)
Head of household
Single individuals
Married filing separately
1
1997
$6,900
$6,050
$4,150
$3,450
1998
$7,100
$6,250
$4,250
$3,550
1999
$7,200
$6,350
$4,300
$3,600
2000
$7,350
$6,450
$4,400
$3,675
20011
$7,6002
$6,650
$4,550
$3,8002
projected
includes recent inflation adjustment
2
A married taxpayer filing a separate return is not allowed to use the standard deduction if his or
her spouse claims itemized deductions.
Each taxpayer over age 65 or blind receives the regular standard deduction plus an additional $850
($900 for 2001) deduction if married and filing a joint or separate return. The additional deduction is
$1,100 (same for 2001) if single or head of household. The additional deductions are subject to the
inflationary adjustment. A taxpayer that is both elderly and blind receives double the additional
deduction. The additional deductions for age and blindness cannot be claimed for dependents.
Personal Exemption .
Personal Exemption Deduction
1997
1998
1999
2000
2001
$2,650
$2,700
$2,750
$2,800
$2,900 est.
Taxpayers are entitled to claim one exemption each for themselves, their spouses, and their
dependents on their federal return. Taxpayers may not claim an exemption for themselves or any other
person who can be claimed as a dependent on someone else’s tax return.
2
The phaseout of the personal exemption for certain high-income individuals was made permanent
by the RRA of 1993. For 2000, the benefit of the personal exemption is phased out for taxpayers with
the following specific high levels of adjusted gross income (AGI). These threshold amounts are up
1.8% from 1999 and are adjusted for inflation annually:
$193,400 if married filing jointly or qualifying widow (er) with dependent child;
(exemptions completely lost at $315,900 AGI)
$161,150 if head of household; (exemptions completely lost at $283,650 AGI)
$128,950 if single (exemptions completely lost at $251,450 AGI)
$ 96,700 if married filing separately; (exemptions completely lost at $157,950 AGI)
The 2001 threshold amounts are projected to be $199,350, $166,100, $132,900, and $99,675
respectively.
The phaseout in personal exemptions is 2% of the exemption amount for each $2,500 increment (or
any fraction thereof) by which AGI exceeds the appropriate threshold amount. A married taxpayer
filing separately will lose 2% of his/her exemption for each $1,250 increment above $96,700.
The personal exemption phaseout or reduction is calculated on a nine-line worksheet called the
Deduction for Exemptions Worksheet included in the 1040 instructions. If adjusted gross income
exceeds the threshold, complete the worksheet before claiming the personal exemption deduction on line
38 of Form 1040.
Example: Mr. and Mrs. Dairy file jointly, have two children, and their 2000 AGI is $253,500.
They claim four personal exemptions and the standard deduction. Their reduction and net exemption are
calculated as follows:
AGI $253,500 - $193,400 threshold = $60,100 excess. $60,100 excess ÷ $2,500 = 24.04
or 25 excess increments. Their reduction is 25 x .02 (2%) = .50 x $11,200 (4 @ $2,800)
= $5,600. Their net personal exemption is $11,200 - 5,600 = $5,600.
A way to evaluate the cost of the personal exemption phaseout to the taxpayer is to calculate the
additional tax liability. In the example, Mr. and Mrs. Dairy are in the 36% taxable income bracket,
where the $5,600 of phased-out personal exemption will cost $2,016 in additional taxes. In other words,
their $60,100 of excess AGI caused an additional tax liability of $2,016 or added 3.0% to their tax
liability and effectively increased their marginal rate to 38.7%.
Dependents
Taxpayers must report the social security numbers of all dependents. The penalty for failure to
report this information is $50. Apply for a social security number by filing Form SS-5 with the Social
Security Administration.
Taxpayers may not claim an exemption for a dependent that has gross income of $2,800 or more
unless it is for their child under age 19 or a full-time student child under age 24 at the end of the tax
year. Nontaxable social security benefits and earnings from sheltered workshops are excluded. A fulltime student must be enrolled in and attend a qualified school during some part of each of five calendar
months. Individuals who can be claimed as dependents on another taxpayer’s return may not claim a
personal exemption on their own return.
For tax years after December 31, 1997 the qualified child, student, or other qualified dependent’s
basic standard deduction allowable is limited to the smaller of the basic standard deduction or (1) the
larger of $700 ($750 in 2001) or (2) the individual’s earned income plus $250.
3
Examples of TRA ’97 Rule Single Taxpayers
Base
Amount
Earned
Income
Earned Income
+ $250
Larger of
the Two
Standard
Deduction
Smaller of
the Two
Case # 1
$700
0
$250
$700
$4400
$700
Case # 2
$700
$4200
$4450
$4450
$4400
$4400
Investment or unearned income in excess of $1,400 received by a dependent child under age 14 is
taxed at the parent’s marginal rate if greater than the income tax using the child rates. A three-step
procedure is required to compute the tax on Form 8615, Tax for Children Under Age 14 Who Have
Investment Income of More than $1,400, where the excess over $1,400 will be taxed at the parent’s
marginal rate and unearned income greater than $700 but less than $1,400 will be taxed at 15%.
The election to claim the child’s unearned income on the parent’s return with Form 8814, Parent’s
Election to Report Child’s Interest and Dividends, is still available, and the adjusted $1,400 base
amount ($1500 for 2001) and $700 ($750 for 2001) tax exemption are indexed for inflation on Form
8814. This election cannot be made if the child has income other than interest and dividends or if
estimated tax payments were made in the child’s name, or the child’s income is more than $6,999
($7499 for 2001).
2000 Tax Rates
All the tax brackets have been adjusted for inflation this year. Each tax bracket has been moved up
approximately 1.9% from 1999, which results in many taxpayers with constant taxable incomes paying
somewhat less income taxes in 2000. Married taxpayers filing jointly with $43,850 of taxable income in
1999 and 2000 will gain $104.00 in tax savings from the adjustments in tax rates.
2000 Tax Rate Schedules
Single Taxpayer
Married Filing Joint Return
& Qualifying Widow(er)
Taxable income
Tax
Taxable income
Tax
$
0 –$ 26,250
15%
$
0 –$ 43,850
15%
*
$26,250 – 63,550 $ 3,937.50 + 28% on excess
$ 43,850 – 105,950 $ 6,577.50 + 28% on excess*
$63,550 – 132,600 $14,381.50 + 31% " "
$105,950 – 161,450 $23,965.50 + 31% " "
$132,600 – 288,350 $35,787.00 + 36% " "
$161,450 – 288,350 $41,170.50 + 36% " "
<$288,350
$91,857.00 + 39.6% " "
>$288,350
$86,854.50 + 39.6% " "
---------------------------------------------------------------------------------------------------------------------------------Head of Household
Married Filing Separate Returns
Taxable income
Tax
Taxable income
Tax
$
0 –$ 35,150
$ 35,150 – 90,800
$ 90,800 – 147,050
$147,050 – 288,350
>$288,350
15%
$ 5,272.50 + 28% on excess*
$20,854.50 + 31% " "
$38,292.00 + 36% " "
$89,160.00 + 39.6% " "
$
0 –$ 21,925
$21,925 – 52,975
$52,975 – 80,725
$80,725 – 144,175
>$144,175
15%
$ 3,288.75 + 28% on excess*
$11,982.75 + 31% " "
$20,585.25 + 36% " "
$43,427.25 + 39.6% " "
* on excess over first number in bracket
The rates for head of household are most favorable. Single taxpayers that are maintaining a home
for themselves and a dependent should qualify. Married taxpayers not living in the same household for
the last six months of the year are treated as married filing separately but may qualify as head of
household if he/she has a qualified dependent.
4
The tax rates for married taxpayers continue to be higher than for single taxpayers. Two married
taxpayers each with $63,000 of taxable income will pay $1,726 more federal income taxes in 2000 than
two singles with the same taxable income. As taxable income increases, the "marriage penalty tax"
increases. A single taxpayer is not subject to the 36% rate until taxable income exceeds $132,600, but a
married taxpayer reaches the 36% tax rate when taxable income exceeds $80,725 per person. Congress
is discussing legislation that will change the marriage penalty tax.
For 2001, the beginning of the 28%, 31%, 36% and 39.6% projected rate brackets will respectively
occur at the following incomes for:
Single taxpayer:
$27,050
$ 65,500
$136,700
$297,150
and qualifying widow(er):
$45,200
$109,200
$166,400
$297,150
Head of household:
$36,250
$ 93,550
$151,550
$297,150
Married filing separate returns:
$22,600
$ 54,600
$ 83,200
$148,575
Married filing joint returns
Itemized Deductions
A taxpayer should itemize if total itemized deductions are greater than his or her standard
deduction. The election to itemize can be made or revoked on a timely filed, amended return. The
limitation for high-income taxpayers must be considered when comparing itemized deductions with the
standard deduction. The itemized deduction 3%/80% reduction rule for married filing separately in
2000 begins at $64,475 (AGI) and the 2000 limit for all other taxpayers starts at $128,950 (AGI).
Taxpayers with a 2000 AGI in excess of $128,950 ($64,475 if married and filing separately) must
reduce all itemized deductions except medical expenses, investment interest, casualty losses, and
wagering losses to the extent of wagering gains. The reduction equals the lesser of 3% of excess AGI or
80% of the applicable itemized deductions. Three percent of excess AGI will be the most common
reduction and will not be a major additional tax burden unless AGI is very high and/or the applicable
itemized deductions are relatively low. The 7.5% of AGI medical expense adjustment and 2% floor on
miscellaneous itemized deductions must be applied before the high-income deduction. (The projected
base for excess calculations for 2001 is $132,900 and $66,450.)
Example: Fred and Ann Veryrich’s 2000 AGI is $148,950. Their itemized deductions total
$17,000 including $12,000 of deductible medical expenses (after the 7.5% AGI deduction) and
investment interest. They claim no casualty or wagering losses. They must reduce their itemized
deductions as follows:
$148,950 AGI - $128,950 maximum = $20,000 excess x .03 = $600. $600 is less than $4,000
(.80 x $5,000 of applicable itemized deductions). They reduce itemized deductions by $600;
$17,000 - $600 = $16,400 adjusted itemized deductions.
Home mortgage interest (qualified residence interest) on the taxpayer’s principal and second home
is an itemized deduction on Schedule A providing the mortgage satisfies the following limitations:
1.
Home Acquisition Loan. Mortgages obtained after October 13, 1987, to buy, build, or improve a
main home or a second home, but only if throughout 2000 the total mortgage debt was $1 million
or less ($500,000 or less if married filing separately). Note: This limit applies to the total debt on
mortgages obtained after October 13, 1987, plus any prior “grandfathered debt”.
5
2.
Home Equity Loan. Mortgages obtained after October 13, 1987, other than to buy, build, or
improve a home, but only if throughout 2000 this debt was $100,000 or less ($50,000 or less if
married filing separately).
To be deductible both types of mortgages must be secured debt, and the mortgage must be recorded
with the county recorder or otherwise perfected under state law.
Mortgage interest that exceeds these limits is nondeductible. However, an exception applies if the
disallowed mortgage interest is deductible under another code section. Also there’s a tax trap if you pay
the mortgage on an ex-spouse’s home, where only the ex-spouse resides after the divorce, there is no
interest deductibility.
Investment interest expense is deductible on the 2000 return and is limited to the amount of net
investment income. Investment interest expense is interest paid on debt incurred to buy investment
property. It does not include investments in passive activities or activities in which the taxpayer actively
participates, including the rental of real estate. Net investment income is gross investment income
(including investment interest, interest received from the IRS, dividends, taxable portion of annuities,
and certain royalties) less investment expenses (excluding interest). Gross investment income was
redefined by the 1993 Act to exclude net capital gain on the disposition of investment property. A
taxpayer may elect to include net capital gain as investment income only if it is excluded from income
qualifying for the long-term capital gain tax rate.
Form 4952, Investment Interest Expense Deduction, is designed to calculate the amount of
carryover interest that may be deducted in the current tax year. The carryover interest deduction is
limited to the excess of current year’s net investment income over investment interest expense, and no
deduction is allowed in any year in which there is a net operating loss.
Personal interest is not deductible.
Medical expenses that exceed 7.5% of AGI are itemized deductions not subject to the additional
2% AGI limit. "Medical expenses" are broadly defined to include payments made for nearly all medical
and dental services, therapeutic devices and treatments, home modifications and additions made
primarily for medical reasons, travel (auto mileage deduction for 2000 is $.10 per mile) and lodging
expenses associated with qualified medical care trips, legal fees required to obtain medical services,
prescribed medicine and drugs, special schooling and institutional care, qualified health insurance
premiums and the costs to acquire, train and maintain animals that assist individuals with physical
disabilities. Most cosmetic surgery, general health maintenance, such as gym fees and weight loss
programs, and well-baby care programs will not qualify. Remember that itemized medical expenses
must be reduced by any reimbursement, including health insurance payments received.
Beginning in 1997, qualified long-term care (LTC) insurance contracts are generally treated as an
accident and health insurance contract. Contract benefits are generally excludable from taxation like
money received for personal injury and sickness. The 2000 excludable per-diem benefit limit is $190
per day or $69,350 annually. Benefits are reported to taxpayer on 1099-LTC and shown on Form 8853
Section B. This exclusion limit is ignored if the actual cost of the LTC is more than the per-diem
payment or that taxpayer has been certified by a physician as terminally ill and death is expected within
24 months of certification.
Long-term Health Care premiums are deductible for 2000, by itemizers when combined with
other premiums and medical expenses that exceed 7.5% of adjusted gross income. However, there are
annual limits on the deductible premiums tied to age. Filers over 70 years old can include long term
6
health care premiums of up to $2,750 per year per person subject to the 7.5% exclusion. Those between
61 and 70 years may include $2,200 per person; 51 to 60 years $820 per person; 41 to 50 years $410 per
person, 40 years and under only $220 per person.
Handicapped taxpayers’ business expenses for impairment-related services at their place of
employment are itemized deductions not subject to the 7.5% or 2% AGI limits. Handicapped taxpayers
are individuals who have a physical or mental disability that is a functional limitation to employment.
Charitable contributions are subject to substantiation and disclosure rules. One set of rules applies
to separate contributions of $250 or more. For separate cash contributions exceeding $250, a taxpayer
cannot rely solely on a canceled check but needs substantiation from the charity showing the amount and
date the contribution was made. Acknowledgment must be obtained from the charity by the earlier of
the filing date or the due date of the return, including extensions. For noncash contributions, the
taxpayer must obtain from the charity a receipt that describes the donated property, a good-faith estimate
of its value, and whether anything was given to the taxpayer in exchange. Taxpayers must use Form
8283 to report total noncash charitable contributions over $500.
For contributions exceeding $75 where the taxpayer receives something in exchange (such as a
dinner), the charity must provide a statement to the taxpayer that informs the donor that the value of the
contribution that is deductible is the difference between the contribution and the value of the goods or
services received by the taxpayer. Also, the charity must provide the donor with a good-faith estimate
of the value of whatever the charity gave to the donor. The standard mileage rate for passenger car use
for charitable causes is $.14 per mile.
Moving expenses are no longer itemized deductions. Report qualified moving expenses on Form
3903 and deduct them on line 26 of Form 1040.
Moving expenses are defined as the reasonable costs of (1) moving household goods and personal
effects from the former residence to the new residence, and (2) travel, including lodging during the
period of travel, from the former residence to the new place of residence. The standard mileage rate for
passenger car use for moving is $.10 per mile. Meal expenses are no longer included. The new place of
work must be at least 50 miles farther from the taxpayer’s former residence than was the old place of
work. The deduction will be subtracted from gross income in arriving at AGI.
The following expenses, previously allowed as moving expenses, no longer qualify: selling and
buying expenses on the old and new residences, meals while traveling or living in temporary quarters
near the new place of work, cost of pre-move house hunting, and temporary living expenses for up to 30
days at the new job location.
Qualified moving expenses reimbursed by an employer are excludable from gross income to the
extent they meet the requirements of qualified moving expense reimbursement (which appears to be the
new definition of deductible moving expenses as described above).
Other itemized deductions not subject to the 2% AGI limit include state income and property taxes,
and personal casualty losses (list not complete).
Miscellaneous Deductions Subject To 2 Percent AGI Limit Include:
1.
Unreimbursed employee business expenses including employment-related educational expenses,
travel, meals and entertainment expenses (subject to 50 percent rule), lodging, work clothes, dues,
7
fees, and small tools and supplies. Employee business expenses reimbursed under a
nonaccountable plan are also subject to the 2% AGI limit.
2.
Investment expenses, including legal, accounting, and tax counsel fees, clerical help and office
rental, and custodial fees.
3.
Job hunting expenses may be deductible if one is looking for employment. Job hunters expenses
are deductible if incurred in looking for a new job in their present occupation. The job searching
expenses are not deductible if looking for a job in a new occupation or looking for a first job.
Factors to determine if the employment is in the same occupation include: job classification, job
responsibility, and nature of employment. The following are expenses that may be deductible: cost
of typing, printing and mailing resumes; long distance phone calls and mailing; career counseling
and agency fees; and travel or transportation expenses.
4.
Other deductions: professional dues, books, journals and safe deposit box rental, hobby expenses
not exceeding hobby income, office-in-the-home expenses, and indirect miscellaneous deductions
passed through grants or trusts, partnerships and S corporations.
Meal expenses must be directly related to the active conduct of the taxpayer’s trade or business (i.e.
an organized business meeting or a meal at which business is discussed). A meal taken immediately
proceeding or following a business meeting will qualify if it is associated with the active conduct of the
taxpayer’s trade or business. The deductible portion of meal and entertainment expenses paid in
connection with a trade or business is 50%. The deductible percentage of the cost of meals consumed
by employees subject to DOT will gradually increase from 60% for 2000 and 2001 to 80% in 2008.
DOT employees include FAA employees (pilots, crews, etc.) railroad employees, and interstate truck
and bus drivers under DOT regulations.
Earned Income Credit (EIC)
Basic earned income credit rates have been gradually increasing, and some low-income workers
without qualifying children are eligible for earned income credit. Earned income includes wages,
salaries, tips and net self-employment earnings but does not include interest, dividends, alimony and
social security benefits.
For taxpayers with one qualifying child, the 2000 EIC is 34.0% of the first $6,920 of earned
income. The maximum credit is $2,353 and is reduced by 15.98% of modified AGI exceeding $12,690.
For taxpayers with two or more qualifying children, the EIC is 40% of the first $9,720 of modified AGI.
The maximum credit is $3,888 and is reduced by 21.06% of modified AGI exceeding $12,690.
The definition of modified AGI for the phase-out disregards certain losses, including: a) losses
from the sale or exchange of capital assets in excess of gains b) net losses from trusts and estates and c)
net losses from non-business rent and royalties. In TRA ’97, the net losses from trades or businesses
computed separately with respect to sole proprietorships, sole proprietorships in farming and other
businesses that are disregarded in determining modified AGI, are increased from 50% to 75%. The
TRA ’97 also expanded the list of included items in modified AGI to include interest that is received or
accrued that is exempt from federal income tax and amounts received as pensions or annuities or IRAs
to the extent not included in gross income.
8
Earned Income Credit Rates, Income Ranges, and Phaseouts*
Earned income range
Maximum
Phaseout
Maximum
credit
Phaseout
rate
credit
For 2000
None
7.65%
$4,610- 5,770
$5,770-10,384
7.65%
$353
One
34.00%
6,920-12,690
12,690-27,415
15.98%
2,353
Two or more
40.00%
9,720-12,690
12,690-31,152
21.06%
3,888
-----------------------------------------------------------------------------------------------------------------------------For 2001
None
7.65%
$ 4,750- 5,950
$5,950-10,695
7.65%
$363
One
34.00%
7,130-13,080
13,080-28,249
15.98%
2,424
Two or more
40.00%
10,010-13,080
13,080-32,092
21.06%
4,004
Qualifying
Children
Credit
rate
*This is not an official IRS table. Do not use these figures in tax preparation as numbers are adjusted annually for inflation and the amount
of credit is normally determined by using EIC tables released by IRS.
It is possible for some low-income taxpayers to be eligible for EIC even though that taxpayer
doesn’t have a qualifying child. To be eligible, such a taxpayer must be age 25 or more, but under 65
years of age. A married taxpayer that does not meet the minimum age requirement may be eligible if his
or her spouse meets the minimum age requirement. Other eligibility rules for the low-income taxpayer
are: he or she cannot be claimed as a dependent or a “qualified child” on another person’s tax return; his
or her principal residence was in the USA for more than one-half of the tax year; the return must cover a
12-month period; the taxpayer cannot file a separate return if married, and cannot file Form 2555 or
Form 2555-EZ. The credit percentage is much smaller (7.65%)for taxpayers with no qualifying
children, and the credit is phased out over a lower income range.
To be eligible for the Earned Income Credit, any taxpayer must have all of the following: (1)
earned income; (2) earned income and adjusted gross income, each below the maximum earned income
allowed; (3) a return that covers 12 months (unless a short-year return is filed because of death); (4) a
joint return if married (usually); (5) included income earned in foreign countries and not deducted or
exclude a foreign housing amount; (6) not be used as a qualifying child making another person eligible
for the earned income credit.
The 1996 Act expanded “disqualified income” to include (among other income items) “capital gain
net income”. To disqualify more taxpayers, the law said gains from the sale of passive investments
should be included as disqualified income. IRS originally said this included gain from sale of assets
used in a trade or business. This interpretation included assets meeting the holding-period requirements
of Sec. 1231 and are not subject to recapture rules of IRC Sec. 1245. In Rev. Rul. 98-56 (November
1998), IRS announced they were reversing their position retroactively as follows:
Section 32 of the Internal Revenue Code allows an earned income credit to eligible individuals
whose income does not exceed certain limits. Section 32(i) denies the earned income credit to an
otherwise eligible individual if the individual’s “disqualified income” exceeds a specified level for
the taxable year for which the credit is claimed. Disqualified income is income specified in section
32(i)(2). Gain that is treated as long-term capital gain under section 1231(a)(1) is not disqualified
income for purposes of section 32(i).
Therefore gain from the sale of equipment and livestock (sows, boars, beef cattle, horses, cull dairy
cows) that are Sec. 1231 property are not disqualified income. This announcement by IRS was not
9
incorporated into their computers for the filing season 1998 nor 1999. Consequently, many taxpayers
were denied the earned income tax credit (EITC) for 1998 and/or 1999 and had to call or resubmit
referencing Rev. Rul. 98-56, to get this credit if they had earned income below the maximum and did
not have disqualified income exceeding $2,300 for the tax year 1998 or $2,350 for the tax year 1999.
In 2000, the EITC is denied to all taxpayers with an excess of $2,400 of taxable and nontaxable
interest income, dividends, net capital gains (excluding those from Sec. 1231 assets) and net income
from rents and royalties not derived in the ordinary course of business. All gains from the sale of
business assets including ordinary gains (Form 4797 Part II) and gains recaptured as ordinary income
(Form 4797 Part III) are not included in disqualified income. The disqualified income level for losing
the entire EIC for year 2001 will be $2,450.
There are three tests for a qualifying child: relationship, residency, and age.
To meet the relationship test, the child must be (1) the taxpayer’s son or daughter or a descendant
of the taxpayer’s son or daughter, (2) the taxpayer’s stepson or stepdaughter, (3) adopted child, (4) foster
child. For the tax year 2000 there is a new definition of eligible foster child.
•
The child is your brother, sister, stepbrother, or stepsister, (or a descendant of one of the
previously mentioned relationships) or has been placed with you by an authorized placement
agency.
•
You cared for the child as you would your own.
•
The child lived with you for the whole year, except for temporary absences.
To meet the residency test, the child must live with the taxpayer in his or her main home for more
than half the year (all year if a foster child), and the home must be in the U.S. However, a child that was
born, or died, anytime in 2000 and lived in the taxpayer’s home will meet the residency test.
To meet the age test, the child must be (1) under 19 at year-end, (2) a full-time student under 24 at
year-end or, (3) permanently or totally disabled at any time during the tax year, regardless of age.
Individuals with qualifying children will not be allowed EIC if they fail to identify those children
by name age and TIN on their returns. TRA ’97 imposed restrictions on the availability of EIC for
taxpayers that improperly claimed credit in prior years. Where there is evidence that a taxpayer’s claim
of EIC was due to fraud, the disallowance period is 10 years after the most recent year for which the
determination was made. Where the claim of EIC was due to reckless or intentional disregard of rules
and regulations, the disallowance period is two years. In addition the taxpayer that is denied EIC may
also be subject to accuracy-related penalty or the fraud penalty.
Earned Income Credit Reminders for Farmers
If earned income is negative, there is no credit. Therefore, a farmer with a negative Schedule F net
farm profit would not get a credit unless there were wage and Schedule C income more than enough to
offset the loss on F, or the optional method of reporting self-employment income is used. A farmer with
a negative 2000 net farm profit may use the optional method of reporting up to $1,600 of selfemployment income, to collect an EIC which would partially or wholly cover the self-employment tax
and thus provide two quarters of social security coverage, providing disqualified income (such as
interest and dividends), earned income, and adjusted gross income are all less than the maximums
allowed.
10
If AGI is greater than the maximum allowed there would be no credit even if earned income is
below the maximum. Many dairy farmers could have a Schedule F profit in the EIC range, but not get a
credit (or at least have it limited) because of gains from cattle sales on 4797 (or any other source of
income that is not classified as "earned") which would be included in AGI.
Before attempting to manage the net farm profit or self-employment income to result in an EIC
with which to pay the SE tax and provide a year’s social security credit, a farmer needs to understand the
EIC rules and the interactions between EIC, SE tax and income tax.
The Earned Income Credit Advance Payment Certificate (Form W-5), may be used by any
employee eligible for EIC to elect advanced payments from his or her employer. EIC payments made
by an employer to his or her employee offset the employer’s liability for federal payroll taxes. Use IRS
tables to determine advanced payments of EIC. Advanced payments are limited to the credit amount for
one qualifying child, regardless of the total number of children a taxpayer may have. An employer's
failure to make required advanced EIC payments is subject to the same penalties as failure to pay FICA
taxes. Employers of farm workers do not have to make advance EIC payments to farm workers paid on
a daily basis (IRS Pub. 225).
Child Tax Credits
For the taxable year 2000 a $500 credit is allowed for each qualifying child under 17 years of age.
For taxpayers with adjusted gross income in excess of the applicable threshold amount, the credit is
phased out. The phaseout rate is $50 for each $1000 of modified adjusted gross income (for fraction
thereof) in excess of the following threshold:
2000 AGI Phaseout Taxpayers With One Child
Married joint return
Single or head of household
Married separate return
Threshold Starting
$110,001
$75,001
$55,001
Completely Gone
$119,001
$84,001
$64,001
For 2000, due to the passage of the “Tax Relief Extension Act of 1999” in late December 1999,
there are some tax benefits in the non-refundable credit section of Form 1040. The education credit,
child credit and dependent care credit, which are all non-refundable may be taken against the total of the
taxpayers regular tax and AMT reduced by the foreign tax credit.
Tentative minimum tax does not reduce the child tax credit for the tax year 2000. Child tax credit
is in addition to the credits for child and dependent care expenses and the earned income credit. The
credit is nonrefundable for taxpayers with 1 or 2 qualifying child (1040 line 47) but may be refundable
for those with 3 or more qualifying children (1040 line 62). Form 8812 for the Additional Child Tax
Credit uses (1) social security and Medicare taxes withheld plus 1040 line 27 (1/2 self-employment tax)
plus 1040 line 53 (social security and Medicare tax on tip income not reported) less (2) 1040 line 60a
(EITC) and 1040 line 61 (excess SS withheld) to limit this refundable credit. Only if the amount in item
(1) is greater than (2) is the difference, a refundable credit.
Many taxpayers with children will have to fill out the AMT Form 6251 for 2000. Approximately
1.3 million taxpayers will owe the minimum tax in 2000. In 1998 about 28% of the minimum tax filers
had AGIs of less than $100,000. These numbers will be greatly effected by the Treasury continuing not
to index AMT to inflation and whether they permanently exclude personal credits from limitation under
AMT rules.
11
Education Incentive Opportunities
In the table below the benefits restrictions and limitations on several tax incentives for participants
in higher education are presented.
Education Incentive Opportunities
HOPE Credit
Lifetime Learning Credit
Tax Incentive
Per Student;
100% of first $1,000 and 50% of second
$1,000 used for tuition and fees for higher
education for at least ½ time students
incurring expenses the tax year
Restrictions
•
Per taxpayer;
20% of first $5,000 (20% of first $10,000
after 2002) for tuition and fees for any higher
education including upgrading skills paid, on
behalf of taxpayer, spouse, or dependent to
whom taxpayer is allowed an exemption.
• Credit may not be claimed in the same tax
year for the same person as claimed for the
HOPE credit.
• May not be claimed in same year as an
education IRA distribution.
• Nonrefundable.
Only for first two post secondary years.
May not be claimed in same year as an
education IRA distribution.
• Maximum of two tax years.
• Nonrefundable.
• Not allowed for persons claimed as
dependents on another taxpayer’s return.
Phaseout starts at $40,000 and is gone at
$50,000 for singles; $80,000 to $100,000
for joint returns; the credit is not available
to married filing separately.
Education IRA
Up to $500 nondeductible contribution per
beneficiary as a trust account for qualified
higher education expenses for the
withdrawal year.
Caution: Any balance remaining after
beneficiary reaches 30 or dies are deemed
distributed within 30 days.
• Contributions must be made during
calendar tax year.
• 10% penalty plus tax on unqualified
withdrawals.
• Cash contributions only.
• No contributions after account holder
attains age 18.
Phaseout starts at $95,000 and is gone at
$110,000 for singles; $150,000 to
$160,000 for joint returns; and the credit is
not available to married filing separately.
•
Modified Adjusted
Gross Income
Limits
Tax Incentive
Restrictions
Modified Adjusted
Gross Income
Limits
Phaseout starts at $40,000 and is gone at
$50,000 for singles; $80,000 to $100,000 for
joint returns; the credit is not available to
married filing separately.
Student Loan Interest Deduction
An above the line deduction, where no
itemization required of
up to $2000 for 2000
up to $2500 after 2001
for interest paid on loans for higher education
expenses while at least ½ time student.
•
Deduction is allowed only with respect to
interest paid during the first 60 months in
which interest payments are required.
• No deduction if student is allowed as
dependent on another taxpayer’s return.
• No double benefits, as in home equity
loans.
Phaseout starts at $40,000 and is gone at
$55,000 for singles; $60,000 to $75,000 for
joint returns; and the deduction is not
available to married filing separately.
The following is a review of “constructive” payments by a cash basis taxpayer.
a) Amounts paid with borrowed funds are deductible when paid, not when the loan is repaid.
b) When a bank credit card is used to pay an expense, the payment is considered to have been
made in the year the credit charge is made, regardless of when the cardholder pays the bank.
12
c) For cash basis businesses, payment is received at the time the check is delivered to the payee
provided it later is paid by the bank. For cash basis business expenses, the date of mailing the
check is the date of payment. But in the case of wages IRS ruled wages are not constructively
paid for withholding and employment tax purposes when they are mailed to employees on the
last day of the year and not received the same day.
Estimated Tax Rules
The minimum threshold after subtracting income tax withholding and credits for estimated tax
payments was increased to $1000 effective for tax years after 1998. To avoid underpayment of
estimated tax, individuals with prior year AGI not exceeding $150,000 ($75,000 if married, filing
separately), must make timely estimated payments at least equal to (1) 100% of last year’s tax, or (2)
90% of the current year’s tax liability. A change is for individuals who exceed the $150,000 ($75,000 if
married filing separately) prior year’s AGI amount as shown below:
Estimated Tax Payment Due For
Tax Year
2000
2001
Safe Harbor Percentage
108.6% of 1999 tax liability
110% of 2000 tax liability
Similar rules apply to trusts and estates.
Farmers and fishermen who receive at least two-thirds of their total gross income from farming are
exempt from estimated tax payments, providing they file and pay taxes by March 1. New York State
officially follows the federal definition of gross income from farming.
Limitation on Compensation for Retirement Plan Calculations
The maximum amount of compensation that can be taken into account under qualified retirement plans,
SEPs, etc., was lowered to $150,000 by the ’93 tax act. This amount is adjusted annually for inflation,
but only in increments of $10,000. If the annual adjustment calculates to less than $10,000, no
adjustment will be made. The 2000 maximum amount is $170,000. Transition rules apply to
governmental plans and plans maintained under a collective bargaining agreement.
Employer-Provided Education Assistance
The exclusion for up to $5,250 of employer-provided educational assistance for undergraduates has
been extended and is available for courses beginning before January 1, 2002.
LONG TERM CAPITAL GAINS RATES
Capital gains taxation has not been changed by legislative action for 2000 tax reporting. The tax
rates on net capital gains for individuals, estates and trusts were reduced and holding periods were
generally increased by the TRA of ’97. Then the RRA of ’98 reduced the required holding period from
18 to 12 months for most assets sold after 1997 to qualify for the 20% maximum adjusted net capital
gain rate. (The reader should refer to prior year publications for further details if dealing with
transactions for 1997.) Some assets are excluded from adjusted net capital gains and are ineligible for
the lowest long-term rates. Cattle and horses (dairy, breeding, sport or draft) must be held 24 months to
qualify for the lower capital gain rates. Short-term gains are still taxed as ordinary income.
13
A taxpayer receiving capital gains distribution dividends no longer reports this first on Schedule
B but enters them directly on Schedule D. If the taxpayer otherwise would not be required to file a
Schedule D, these distributions may be entered directly on Form 1040, check the box and calculate the
alternative capital gains tax on the worksheet provided in the IRS instructions.
Installment sale payments are taxed under the rates in effect for the year received and not those
in effect in the year of the actual sale.
Gain from the sale of Sec. 1250 property (general purpose buildings and other depreciable real
estate) that would be ordinary income under Sec. 1245 depreciation recapture rules and which has not
already been taxed as ordinary gain under Sec 1250, has a maximum tax rate of 25%. The maximum
rate on net capital gain from the sale of collectibles and certain small business stock remains at 28%.
The maximum tax rate on adjusted net capital gain is scheduled to be reduced to 18% (8% for
income in the 15% taxable income bracket) after 12/31/2000. To be eligible for this rate the asset needs
to have been held 5 years. The 20% and 10% rates will still apply to assets held the regular holding
period of 12 (or 24) months. For taxpayers in the 15% bracket, the holding period begins as normal with
the date of acquisition. For taxpayers in a taxable income bracket in excess of 15%, only assets acquired
after December 31, 2000 qualify. Therefore, for higher bracket taxpayers, an asset sold before 2006
would not qualify for this reduced rate unless the taxpayer elects to treat the asset as having been sold
and reacquired for its fair market value on 1/1/2001. Gain must be recognized and losses disallowed
under this option. Few taxpayers would benefit from this election.
Adjusted Net Capital Gain Exclusions
Adjusted Net Capital Gain (ANCG) excludes unrecaptured gain from the sale of Sec. 1250 assets
(general-purpose buildings), gain on collectibles and Sec. 1202 small business stock gain.
Computing Net Capital Gain
Remember that some or all of capital gain income can be taxed below its maximum rate if the
taxpayer is in the 15% taxable income bracket. Non corporate taxpayers will compute their 2000 net
capital gains tax by applying capital gain income to the 15% taxable income bracket in the following
order:
1. Unrecaptured Sec. 1250 gain (25% maximum is reduced to 15%).
2. Collectibles and other 28% rate gain assets (28% maximum is reduced to 15%).
3. Adjusted net capital gain (20% maximum is reduced to 10%).
4. Adjusted net capital gain in excess of the 15% taxable income bracket is taxed at 20%.
Example: Mr. and Mrs. F. P. Moor, file a joint return and their 2000 15% taxable income tax
bracket goes to $43,850. Their taxable income after personal exemptions and itemized
deductions is $49,000 exceeding the 15% bracket by $5,150. Their taxable income includes
$6,000 unrecaptured Sec. 1250 gain from the sale of a farm building, $3,500 of capital gain
14
from the sale of antiques, and $10,000 of adjusted net capital gain from the sale of dairy
cattle. The $6,000 unrecaptured Sec.1250 gain and the $3,500 capital gain on collectibles is
all taxed at 15%. $4,850 of their adjusted net capital gain ($10,000 ANCG - $5,150 15%
bracket excess), is taxed at 10%. The remaining $5,150 of ANCG is taxed at 20%.
5. Apply the 25% net capital gain tax to any unrecaptured Sec. 1250 gain exceeding the 15%
bracket.
6. Apply the 28% net capital gain tax to any 28% rate gain assets exceeding the 15% bracket.
Netting Capital Gains and Losses
The RRA of 1998 provides the following rules for capital gains and losses for tax years ending
after May 6, 1997.
1. Short-term capital losses including carryovers are combined with short-term capital gains.
Any net short-term capital loss is used to reduce long-term capital gains in the following
order: 28% sale gain, unrecaptured Sec. 1250 gain (25%), and adjusted net capital gain
(20%).
2. Gains and losses are netted within the three long-term capital gain groups to determine a net
capital gain or loss for each group. There can be no net loss in the 25% group, which is
limited to gain to the extent of straight-line depreciation.
3. A net loss from the 28% group (including long-term capital loss carryovers) is used to reduce
gain in the 25% group, and then any net loss balance is carried to the 20% group.
4. A net loss from the 20% group is used to reduce gain from the 28% group and any remaining
net loss is carried to the 25% group.
Note that long-term capital loss carryovers are used to reduce gains and/or increase loss in the 28%
group regardless of the source of that carryover.
Inherited Property Rules
TRA ’97 and RRA ’98 did not change the step-up in basis rule that gives decedent’s property a
new basis equal to its FMV on the date of death (or alternative valuation date). Only gain that occurs
after that date will be subject to income tax. Inherited property (except for Sec. 1231 livestock) will
automatically be considered held the required holding period for long term capital gains treatment.
Other Provisions
AGI will still include the entire net capital gain and will continue to influence the determination
of the floor on certain itemized deductions, the phaseout of personal exemptions and itemized
deductions.
The new, lower long-term capital gains rates will be used to compute AMT (Form 6251, page 2).
Entities such as S corporations, partnerships, estates and trusts may pass through capital gains to their
15
owners or beneficiaries and must make the determination of when a long-term capital gain is taken into
account on its books.
On the sale or exchange of small business stock (Sec. 1202 stock), held for more than five years,
50% of the gain may be excluded from the taxpayer’s gross income. The remaining capital gain is taxed
at 28%. Gain eligible for the 50% exclusion may not exceed the greater of $10 million or 10 times the
taxpayer’s basis in the stock. If such small business stock is sold before meeting the five year holding
requirement, there is no exclusion and the gain will be taxed at the 20% maximum capital gains tax rate
(if the required holding period has been met).
SALE OF TAXPAYERS PRINCIPAL RESIDENCE
The TRA of ’97 increased the exclusion of gain from the sale of a principal residence to
$250,000 ($500,000 for joint filers), on sales and exchanges made after May 6, 1997. The old
rollover of gain provision (IRC Sec. 1034) and the $125,000 of gain exclusion, including the 55
years of age requirement (old IRC Sec. 121), were repealed and replaced with a new exclusion (new
IRC Sec. 121).
The new exclusion can be used by taxpayers of any age on each home they have owned
and used as a principal residence for at least two years during the five-year period ending on the
sale date. Use of the exclusion is limited to once every two years beginning May 7, 1997.
Earlier sales do not count. Use of the old exclusion prior to May 7,1997 does not affect the
availability of the new exclusion. Married taxpayers filing joint returns get a $500,000 exclusion
if either spouse has owned the residence for at least two years, both spouses have lived in it for at
least two years and neither spouse has used the new exclusion in the past two years.
Married spouses who qualify for the $500,000 exclusion may elect to exclude $250,000
of gain from the sale of each spouse’s principal residence within a two-year period. Those
married filing jointly but living apart also get the $250,000 exclusion on the qualified sale of
each spouse’s principal residence. A recently married spouse does not lose eligibility for the
$250,000 exclusion by marrying a taxpayer that has used the exclusion within two years.
A partial exclusion may be claimed by taxpayers that have excluded the gain on the sale
of another home sold after May 6, 1997 and within two-years of the current sale, if the current
sale was due to a change in place of employment, health or unforeseen circumstances.
Example: Mr. and Mrs. Move sold and moved out of their first home March 1, 2000 due
to a change in employment. They began renting and living in that home on June 28, 1998 but did
not buy it until August 4, 1998. They lived in the home for 611 days but owned it for only 574
days. Their partial exclusion is based on the portion of the two-year (730 days) ownership
requirement that they lived in the house (574 days), the shorter of the two requirements. Their
partial exclusion for 2000 is $393,150 (574 ÷730 = .7863 x $500,000 = $393,150).
The length of ownership and use of the current principal residence may include the period
of ownership and use of prior residences on which gain was rolled over to the current residence
(under prior law, IRC Sec. 1034). For example, if the home sold by Mr. and Mrs. Move in the
16
above example had been their second home, and the gain from the sale of the first home owned
and used for more than one-year was used to reduce the basis of the second home, they would
qualify for the full exemption.
Gains from insurance proceeds and other reimbursements for homes destroyed or
condemned after May 6, 1997 qualify for the exclusion. The sale of a remainder interest in a
home to a person related to or entity owned by the taxpayer does not qualify. Gain equal to any
depreciation allowed or allowable for the business use of a home after May 6, 1997, can not be
included in the exclusion.
Other specific rules: 1) affect transfers incident to a divorce, 2) define time of ownership for
surviving spouses, and 3) define periods of use for taxpayer’s transferred to nursing homes.
Previously Form 2119 was used to report the sale of principal residences. That form has been
discontinued. If any gain is to be recognized the sale is reported directly on Schedule D. On the line
directly below that used to report the total gain, the exclusion amount (if any) is listed as a loss with a
description of "Section 121 exclusion". If no gain is to be recognized, no reporting is required.
A taxpayer that does not meet the two-year ownership test and/or the two-year use
requirement will be also be eligible for a partial exclusion if the principal residence was in
qualified use on August 5, 1997 and is sold before August 6, 1999. As illustrated above, the
partial exclusion is based on the lesser of, days of qualified ownership or days of qualified use,
during the five-year period ending on the sale date divided by 760 days.
INCOME AVERAGING FOR FARMERS
Individual taxpayers with certain farm income may elect to use a new three-year method of
income averaging for tax years beginning on or after January 1, 1998. “Elected farm income” (EFI) is
deducted from the current year’s taxable income and, in effect, one-third of it is added to each of the
three prior year’s taxable income to be taxed at the rates of those prior years. C corporations, estates and
trust, may not use the election.
“Elected farm income” is taxable income attributed to any farming business and designated to be
included in the election. Gains from the sale of farm business property (excluding land and timber)
regularly used in farming for a substantial period, may be included in EFI. Farm net operating losses
must also be included. A “farming business” includes nursery production, sod farming, the production
of ornamental trees and plants as well as the production of fruit, nuts, vegetables, livestock, livestock
and horticultural products, and field crops. However, gain from the sale of trees that are more than 6
years old when cut is not eligible farm income, as these trees are no longer classified as ornamental
trees. Neither is the income, gain/loss from the sale of grazing nor development rights or other similar
rights classified as attributable to a farming business.
The terms “regularly used” and “substantial period” are not defined in IRC or committee reports.
Regulations (§1.1301-1) have clarified that if a taxpayer ceases farming and later sells farm business
property (other than land) within a reasonable time after the cessation, the gains or losses from the sale
17
will be considered farm income. If the sale is within one year, it will be deemed to be within a
reasonable time. Sales beyond one year one will need to consider all facts and circumstances.
The tax imposed when income averaging is elected will be the current year’s federal income tax
liability without the EFI, plus the increase in the three prior years tax liability caused by the carryback of
EFI. The election does not apply to self-employment tax or AMT. Current year’s EFI is subject to SE
tax and AMT in the election year, not in carryback years. Note that this provision may result in tax
savings from income averaging being offset by increases in AMT.
Farm taxpayers who elect income averaging will be able to spread taxable farm income over a
four-year period and designate how much and what type of farm income (ordinary or capital gains) to
include in EFI. Schedule J is used to compute and report the tax from income averaging.
Farm Income Averaging Example
Dairy farmers Mr. and Mrs. B & B Goodyear have a substantial increase in farm income in 2000.
Receipts are up and costs are down. Mrs. Goodyear works off-farm. They file a joint return, claim two
exemptions and use the standard deduction. Their taxable income for 2000 and the previous three years
is determined as follows:
Year
2000
1999
1998
1997
Sch. F
Profit
$38,000
4,000
17,000
6,000
+
Sec. 4797 Cattle
Sales(cap. gains)
$20,000
18,000
12,000
16,000
Other
+ Income
$22,800
18,600
22,200
15,400
Pers. Exemp.
- Std. Ded.
$12,950
12,700
12,500
12,200
=
Taxable
Income
$67,850
27,900
38,700
25,200
The Goodyears elect to income average in 2000. Their maximum EFI is $58,000 (taxable
income attributed to farming). Their optimum EFI may be taxable income that exceeds their 15% tax
bracket or $24,000 ($67,850 – $43,850). They decide to use $24,000 of their Sch. F profit as 2000 EFI
and carryback $8,000 to each of the last 3 years.
Will all of the EFI be taxed at 15%? In 1998 their 15% tax bracket ended at $42,350, their
taxable income was $38,700 leaving $3,650 of the 15% rate bracket available for EFI from the current
year. Therefore $4,350 ($8,000-$3,650) carried back to 1998 will be taxed at 28%.
Should the Goodyears reduce EFI to avoid the 28% tax bracket in 1998? For each $1 of EFI
subject to the 28% tax rate in 1998, $2 is taxed at 15% in the other carryback years. The marginal tax
rate for the Goodyear’s EFI is 19.33% ([.15 + .15 + .28] ÷3). If they put less than $24,000 in 2000 EFI
their 2000 taxable income will exceed $43,850 and their marginal tax rate will be 28%.
How much income tax will the Goodyears save by income averaging in 2000? They will save
13% (28-15) on the first $10,950 (3 x $3,650) or $1,424, and 8.67% (28-19.33) on the remaining
$13,050 of EFI or $1,131, for a total tax reduction of $2,555.
18
Questions and Answers
1. What taxpayers qualify for farm income tax averaging?
Sec. 1301 says, “individuals engaged in a farming business” qualify and specifically excludes estates
and trusts. IRS instructions indicate that individual owners of partnerships, LLCs and S corporations
qualify (farm income flows through the business and retains its character in the hands of the individual
owner taxpayer). C corporations and their owners do not qualify for farm income averaging (although
they are not specifically excluded by IRC Sec. 1301).
2. Does EFI retain its character as it is carried back and may the taxpayer select the type of
income to include in EFI?
Taxpayers will be allowed to carryback ordinary farm income and keep capital gains in current year
taxable income, or select the best combination of ordinary farm income and qualified capital gains to
meet their tax management objectives. When a combination of ordinary farm income and capital gains
is included in EFI, the IRS indicates that an equal portion of each type of income must be added to each
prior year. The taxpayer cannot add all of the capital gains to a single prior year.
Any capital gain that is carried back to prior years will be treated at the capital gains tax rate in effect for
that prior year. Therefore 2000 farm business gains of a taxpayer in a 28% income tax bracket could be
subject to a 10% tax rate if the taxpayer has a base period in the 15% income tax bracket and includes
these gains in elected farm income.
3. Do farm owners who rent their farm or land for agricultural production qualify?
If the farm owner materially participates in the farming activity and properly reports the income on Sch.
F, this income appears to qualify for income averaging. If the farm owner does not materially
participate but receives share rental income this income is properly reported on Form 4835. IRS
instructions do not include Form 4835 in its list of forms on which farm income and expense are
typically reported. Therefore, non-materially participating landowner rental income is presumably not
eligible for averaging. Cash rental income reported on Sch. E is not income attributable to a farming
business.
4. How much farm use is required to meet the “regularly used” in farming rule that applies to
gains from the sale of farm business property?
All sales reported on Sch. F are qualified. Sales of raised dairy and breeding livestock reported on Form
4797 qualify. Sales of farm property for which depreciation and Sec. 179 deductions are claimed also
qualify. Therefore it appears as if all sales of farm machinery, buildings, livestock and other eligible
Sec. 1231 property qualify as “regularly used”.
5. How long is the holding period required to meet the “substantial period” rule?
It is likely that the only farm sales required to meet the “substantial period” are those reported on Form
4797. But “substantial period” has not been defined. The IRS regulations indicate that "substantial
period" depends on all the facts and circumstances.
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6. If Sec. 1231 gain is part of EFI, is it subject to recapture due to unrecaptured Sec 1231 losses in
the carryback years?
IRS instructions indicate that any net capital gains shifted to a prior year that had a capital loss do not
offset that loss. The loss remains as a capital loss carryover. Presumably this same approach would be
applied to Sec. 1231 gains which would then be taxed as long-term capital gains in the prior year.
7. Can the election to income average be made on an amended return?
The election to use income averaging can be made up to the due date of the taxpayer’s return, including
extensions. Treas. Regs. under § 301 provide for this 6 month election window even if the tax return
was actually filed by its original due date. Thereafter, IRS Publication 553 says that an election can be
made, changed or revoked only if there is another change on the tax return for the election year or a base
year (by amendment or audit), or by consent of the IRS.
8. If a prior year return reflected an NOL carryover that was only partially applied, will
additional NOL carryover be used in that prior year when one-third of this year's EFI is "carried
back"?
No, the amount of the NOL applied is not refigured to offset the EFI added to that prior year. Similarly,
base year’s income, deductions and credits are not affected by the additional income allocated to that
year (for example, the taxable portion of Social Security benefits or the allowable Schedule A Itemized
Deductions.
9. Can base period taxable income be less than zero?
No, base period taxable income cannot be negative. Tax management to avoid negative taxable income
and the loss of personal exemptions and potentially the standard deduction is therefore still prudent.
10. Must a taxpayer use the same filing status in each year?
No, the tax will be computed based on the filing status in effect for each base year and the election year.
11. What tax rate will be used for the “Kiddie” Tax when income averaging has been used on the
parents’ tax return?
The tax rate is the parents’ tax rate after farm income averaging has been applied.
12. Can a taxpayer use income averaging even though it provides no current year tax savings?
Yes, though you may have to override your tax preparation software in order to print the Schedule J.
This technique may be used to shift income to the oldest base period year which will drop out of the
calculations for the following year. This may allow the evening out of base period years in anticipation
of income averaging in future years.
13. Can the use of income averaging create or increase AMT liability?
Yes, since income averaging does not affect the calculation of tentative AMT on Form 6251. AMT is
20
the excess of tentative AMT over the regular income tax. Therefore, as income averaging reduces
regular tax, the potential for an AMT tax liability increases.
14. Will any increased AMT resulting from income averaging be available as an AMT credit in
future years?
Not always. Only adjustments and preferences that are deferral items create an AMT credit. If there are
no such deferral items, or such items have already been reflected in an AMT credit calculated before
income averaging has been used, no additional AMT credit will be created.
Planning Guidelines and Information
Implement economically sound income tax management practices throughout the year rather than
using income averaging as the only tax management strategy. Use tax management practices that reduce
taxable income before income averaging is elected.
Tax Planning Note: If the taxable income in a base year, is less than the Adjusted Net Capital Gain
of that year, elected farm income carried to that year will be taxed at the net capital gains rate until
adjusted taxable income of that base year equals that year’s ANCG. This is true even if the elected farm
income is ordinary income and is not ANCG itself.
Income averaging should be used to transfer as much as possible of high bracket income from the
election year, to low bracket income in the carryback years. There will be cases where EFI carried back
to one or more years is not taxed in the lowest bracket but income averaging will still saves taxes. A
farm taxpayer needs the following information to determine if and how much 2000 farm income should
be averaged:
1. Estimates of 2000 adjusted gross income, ordinary income and capital gain attributed to farming,
personal exemptions and the standard (or itemized) deduction.
2000 Personal Exemption and Standard Deductions*
Personal exemption
Standard deduction:
$2,800
Single
$4,400
Married filing jointly
$7,350
Head of household
$6,450
Married filing separately
$3,675
--------------------------------------------------------------------------------------------------------------------* Additional amounts for taxpayers over 65 and/or blind taxpayers are not included.
2. Taxable income from his or her 1997, 1998 and 1999 tax returns.
3. Taxable income tax brackets for 2000 and the 3 prior years. (see chart provided)
21
High End of Taxable Income Tax Brackets
Filing Status
Single
Bracket
15%
28%
31%
36%
2000
$26,250
$63,550
$132,600
$288,350
1997
$24,650
$59,750
$124,650
$271,050
1998
$25,350
$61,400
$128,100
$278,450
1999
$25,750
$62,450
$130,250
$283,150
Married Filing Jointly
15%
28%
31%
36%
$43,850
$105,950
$161,450
$288,350
$41,200
$99,600
$151,750
$271,050
$42,350
$102,300
$155,950
$278,450
$43,050
$104,050
$158,550
$283,150
Head of Household
15%
28%
31%
36%
$35,150
$90,800
$147,050
$288,350
$33,050
$85,350
$138,200
$271,050
$33,950
$87,700
$142,000
$278,450
$34,550
$89,150
$144,400
$283,150
Married Filing
Separately
15%
28%
31%
36%
$21,925
$52,975
$80,725
$144,175
$20,600
$49,800
$75,875
$135,525
$21,175
$51,150
$77,975
$139,225
$21,525
$52,025
$79,275
$141,575
CCC COMMODITY LOANS AND LOAN DEFICIENCY PAYMENTS
Low commodity prices are causing farm producers to use government programs that have not been
used in the past few years. As market prices for commodities fall below the marketing assistance loan
rates offered by the Commodity Credit Corporation (CCC), producers can realize more income by
taking advantage of one or more of the government options. Those options and the income tax consequences are as follows:
CCC Nonrecourse Marketing Assistance Loan
Instead of selling a commodity, producers can use the commodity as collateral for a nonrecourse
loan from the CCC. This option puts cash in the producer’s pocket at the time of harvest and lets the
producer wait to see whether market prices improve.
I.R.C. §77 provides for a binding election to treat these loans as income in the year received.
If the producer has not made the I.R.C. §77 election, the CCC loan is treated the same as any other
loan.
If market prices subsequently rise above the loan rate, producers will choose to repay the loan, with
interest, and then sell the commodity for more than the loan.
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The income tax consequences of the sale depend upon whether or not the I.R.C. §77 election has
been made. In any event, the interest expense is deductible on Schedule F.
Typically, the I.R.C. §77 election has not been made so the producer has no basis in the commodity.
Therefore, the full sale price must be reported as Schedule F income.
If the I.R.C. §77 election has been made, the producer has basis in the commodity equal to the
amount of the loan. That basis is subtracted from the sale price to determine the gain on the sale (which
is reported in the resale section of Schedule F).
If market prices do not rise above the loan rate, producers will choose to redeem the commodity by
paying the posted county price (PCP) to the CCC. By making that payment, the producer is no longer
obligated on the loan and can keep the difference between the loan rate and the PCP. This option
replaces the option of forfeiting the grain to the CCC under the old loan program.
A producer who redeems the commodity by paying the PCP will receive a Form CCC-1099-G from
the CCC for the difference between the loan rate and the PCP. That amount must be reported as an
Agricultural Program Payment on Schedule F.
However, if the producer made a §77 election, the difference between the loan rate and the PCP is
not reported as taxable, since the full loan amount has already been reported on line 7a on Sch. F.
Instead, this difference is subtracted from the producer’s basis in the commodity so that the producer
now has basis in the commodity only equal to the PCP.
Loan Deficiency Payment
If market prices are below loan rates, producers can simply claim a loan deficiency payment (LDP)
for their crops rather than borrowing from CCC. That payment is equal to the difference between the
loan rate and the PCP on the date the LDP is claimed. Producers get the same result as if they had taken
the loan and paid the PCP rate on the date they claimed the LDP.
The LDP is reported as an Agricultural Program Payment.
Note: Reconciling taxpayer records to the amounts reported on Form CCC-1099-G can be
challenging:
1. CCC loan activity is not reported on the 1099. Borrowings and program payments may be comingled in taxpayer records.
2. Often, advance government payments are made. Then if market conditions are better than
expected, these advances must be repaid. Sometimes these payments are simply netted from
subsequent government payments. Sometimes they are paid by taxpayer check and can be
confused with LDPs or repayments of CCC loans.
3. Program payments are typically direct deposited to the producer’s bank account. Sometimes,
these payments are applied directly to CCC loan payments.
4. Interest paid to CCC on loans is not reported to the taxpayer on a 1099.
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PROVISIONS APPLYING PRIMARILY TO BUSINESS ACTIVITY
Business Use of Home
Expenses associated with the business use of the home are deductible only if they can be attributed
to a portion of the home or separate structure used exclusively and regularly as the taxpayer’s principal
place of business for any trade or business, or a place where the taxpayer meets or "deals with"
customers or clients in the ordinary course of business. Because a farmer’s principal place of business is
the entire farm, and most farmers live in homes that are on the farm, an office in their home would be at
their principal place of business (Pub. 225). A self-employed farmer who lives on the farm must still
use the home office exclusively and regularly for farm business in order to deduct the applicable
business use of home expenses.
“Exclusive use” means only for business. If a farmer uses the family den, dining room or his
bedroom as an office, it does not qualify. “Regular use” means on a continuing basis and a regular
pattern of use should be established. “Regular use” does not mean constant use. The office should be
used regularly in the normal course of the taxpayer’s business.
For tax years beginning after December 31, 1998 the home office rules are more relaxed. The
definition of principal place of business was expanded. It allows a deduction for administration and
management even through the work is performed elsewhere. IRC 280A(c)(1) indicates that a home
office will qualify as the principal place of business if: 1) the office in the home is used for the
administrative or management activities of the taxpayer’s trade or business, and 2) there is no other
fixed location where the taxpayer conducts substantial administrative or management activities of the
trade or business. All other rules continue to apply. The space must be used exclusively and regularly
for business. IRS Pub. 587 provides great examples that describe 4 situations in which a taxpayer’s
home office will qualify even if the use before 1999 did not qualify for the deduction.
Form 8829, Expenses for Business Use of Your Home, is not filed with Schedule F, but it may be
used as a worksheet to help farmers determine the appropriate expenses to claim. Applicable expenses
for business use of the home include a percentage of the interest, taxes, insurance, repairs, utilities and
depreciation claimed.
Farmers who reside off the farm, crop consultants and sales representatives will be allowed home
office deductions if they meet two additional rules. Home office activities must be equal to or of greater
importance to their trade or business, than are non-office activities and time spent at the home office
must be greater than that devoted to non-office activities.
Schedule C filers who claim expenses for business use of the home must file Form 8829. Form
4562 will be required if it is the first year the taxpayer claims such expenses. Limitations on use of
home expenses as business deductions are calculated on Form 8829.
Caution: When a taxpayer sells a home on which expenses for business use have been claimed,
tax consequences may occur.
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Transportation Expenses. When a taxpayer has two established places of business, the cost of traveling
between them is deductible as an ordinary and necessary business expense under Sec. 162, because the
taxpayer generally travels between them for business reasons. However, when one business is located at
or near the taxpayer’s residence, the reason for travel can be questioned. In Rev. Rul. 94-47 IRS takes
the position that transportation expenses incurred in travel from the residence are only deductible if the
travel is undertaken in the same trade or business as the one that qualifies the taxpayer for a deductible
home office.
Business trip expenses for a spouse, dependent or other individual are not deductible unless the
person is an employee of the person paying or reimbursing the expenses, the travel is for a bona fide
business purpose, and the expenses for the spouse, dependent or other individual would otherwise be
deductible.
Self-employed Health Insurance Premiums
This tax provision allows self-employed taxpayers to deduct as an adjustment to income on 1040 a
percentage of health insurance premiums paid. Also if you pay premiums on a qualified long-term care
contract for yourself, your spouse, or your dependents you can include these premiums, subject to the
annual limits stated previously. In 1999 to 2001 the deduction is 60%, with the balance subject to the
7.5% rule for those who itemize. The deduction will be 70% for the tax year 2002 and fully deductible
beginning in the year 2003. Self-employed taxpayers include sole proprietors, partners and more than
2% S corporation shareholders.
Qualified health insurance premiums are limited to health insurance coverage of the taxpayer
and/or the taxpayer’s spouse and dependents. The deduction may not exceed earned income. It does not
reduce income subject to self-employment tax and that part may not be included in medical expenses
claimed as itemized deductions. A taxpayer eligible for coverage in an employer’s subsidized health
insurance plan may not deduct insurance premiums he or she pays even if it is the taxpayer’s spouse that
is the employee. Eligibility is tested monthly.
Employee Health and Accidental Insurance Plans
An employer can claim premiums paid on employee health and accident insurance plans as a
business expense on Schedules F or C. The payments are not included in employee income (I.R.C. Sec.
105 (b)). Plans purchased from a third party (an insured plan) as well as self-insured plans qualify but
the latter are subject to nondiscrimination rules.
Health insurance purchased for an employee’s family qualifies, even if a member of that family is
the employer. A taxpayer operating a business as a sole proprietorship can employ his or her spouse,
provide health insurance that covers the spouse-employee and the family of the spouse-employee
(including the employer), and deduct the cost as a business expense (Rev. Rul. 71-588).
A written plan is not required if it is purchased through a third-party insurer. Self-insured plans
must have a written plan document that describes the expenses and benefits paid by the employer. A
plan that reimburses an employee for health insurance premiums paid by the employee can work but
direct payment of premiums by the employer is less complicated and is recommended.
25
The following rules apply when the taxpayer employs his or her spouse, pays the family health
insurance premiums as a nontaxable employee benefit, and deducts them as a business expense:
1.
The spouse must be a bona fide employee with specific duties and the salary and benefits received
must be proportionate to the duties.
2.
The employer must file all payroll reports, withhold income and FICA taxes and furnish a Form W2 to the employee.
The advantages of paying the family health insurance premiums this way are a reduction of
Schedule F or C net income, a reduction of combined taxable income, a potential reduction in selfemployment income and a potential net tax savings. The disadvantages are additional bookkeeping,
payroll tax deposits, a possible increase in social security taxes (if the employer’s earnings are above the
earnings base), and a potential reduction in social security benefits to the employer.
Business Use of Automobiles
Automobile expenses are deductible if incurred in a trade or business or in the production of
income. Actual costs or the standard mileage rate method may be used. The 2000 standard mileage rate
is 32.5 cents per mile for all business miles driven (leased as well as purchased vehicles). The standard
mileage rate may not be used when the automobile has been depreciated using a method other than
straight line, the car is used for hire or two or more cars are used at once. The use of Section 179,
ACRS, or MACRS depreciation also causes disqualification from using the standard rate. When a
taxpayer uses the standard rate on a vehicle in the first year it is used in the business, the taxpayer is
making an election not to use MACRS depreciation or Section 179.
Effective for tax years beginning after December 31, 1997, a rural mail carrier that receives a
qualified reimbursement for expenses incurred for use of their vehicle will be allowed a deduction for an
amount equal to the reimbursement received (“a wash”). There is no special mileage rate for rural mail
carriers.
Deductibility of Borrowed Funds to Satisfy Interest Due
Cash basis taxpayers are not entitled to interest deductions in cases where the funds used to pay the
interest due are borrowed from the same lender to whom the interest is owed. Borrowing to satisfy the
interest obligation has been ruled that the obligation was postponed rather than paid. If a taxpayer
borrows to pay the interest from the same lender accurate records must be kept so when the note is paid
the interest that is then deductible is not forgotten. Borrowing from a different lender or borrowing prior
to payment due date and paying multi-obligations from the advance seems to meet the deductibility
requirements.
26
CORPORATE AND PARTNERSHIP PROVISIONS
Corporations
C or regular corporations are subject to federal income tax rates ranging from 15 to 39%. Capital
gains are taxed at the regular corporate rates. A personal service corporation is taxed at a flat rate of
35%.
2000 Corporate Tax Rates For Small Businesses*
Taxable Income
$0 to
$50,000
$50,001 to
$75,000
$75,001 to
$10,000,000
Tax
15%
$7,500 + 25% on amount over $50,000
$13,750 + 34% on amount over $75,000 plus 5%
on taxable income from $100,000 to $335,000
* Tax rates for corporations with more than $10 million of taxable income average approximately 35%.
Salaries and qualified benefits paid to corporate officers and employees are deducted in computing
corporate taxable income, but dividends paid to stockholders come from corporate profits that are taxed
in the C corporation. Corporate dividends are also included in the stockholders taxable income.
A corporation is required to make estimated tax payments equal to 100% of the tax shown on its
return for the current year or on 100% of last year’s tax, if the estimated tax for the year is expected to
be $500 or more.
S corporations have elected not to be a tax paying entity but must file Form 1120S. S corporation
shareholders will include their share of business income, deductions, losses and credits on their
individual returns.
The alternative minimum tax has been repealed, effective January 1, 1998, for small corporations
(less than $15 million of total gross receipts from 1995 through 1997 and not more than $22.5 million in
any succeeding three-year period). The AMT rate remains at 20%, the exemption is $40,000 and the
exemption phase-out rules are unchanged.
Farm family corporations with annual gross receipts exceeding $25 million in any year after
1985 must use accrual tax accounting. Non-family farm corporations with 3 year average annual gross
receipts exceeding $1 million in any year after 1976 must use accrual tax accounting. When farm
corporations become subject to the gross receipt rule and are required to change to accrual accounting,
an adjustment (IRC Sec. 481) resulting from the change is included in gross income over a 10-year
period beginning with the year of the change. TRA’97 replaced suspense accounts with the Sec. 481
adjustment for tax year’s ending after June 8, 1997 and provided phase-out rules for suspense accounts
established under prior law. The rules that require income from suspense accounts to be included in
taxable income when gross receipts decline were retained.
27
Partnership Filing Rules and Issues
A partnership that fails to file a timely and complete return is subject to penalty unless it can show
reasonable cause for not filing Form 1065. A family farm partnership with 10 or fewer partners will
usually be considered to meet this requirement if it can show that all partners have fully reported their
shares of all partnership items on their timely filed income tax returns. Each partner’s proportionate
share of each partnership item must be the same and there may be no foreign or corporate partners.
Schedules L, M-1 and M-2 on Form 1065 are to be completed on all partnership returns unless all
three of the following apply: (1) the partnership’s total receipts are less than $250,000, (2) total
partnership assets are less than $600,000, and (3) Schedules K-1 are filed and furnished to the partners
on or before the due date of the partnership return, including extensions.
Premiums for health insurance paid by a partnership on behalf of a partner for services as a partner
are treated as guaranteed payments. (Usually deductible on 1065 as a business expense listed on Schedules
K and K-1 and reported on Sch. E). For 1999-2001, a partner who qualifies can deduct 60% of the health
insurance premiums paid by the partnership on his or her behalf as an adjustment to income on 1040.
According to IRS instructions, the health insurance may instead be treated as a distribution to the partner
with the resulting effect on capital accounts.
Partnership tax returns may now be filed electronically. Paper Form 8453-P must still be filed by
the partnership.
INCOME TAX IMPLICATIONS OF CONSERVATION AND ENVIRONMENTAL
PAYMENTS AND GRANTS RECEIVED BY FARMERS
Farmers and participating landowners are receiving NYS and/or federal grants and payments for
a number of different conservation and environmental programs. Here is a review of the income tax
consequences associated with some of the programs.
Cost-Sharing Payments Under IRC Sec. 126
Cost-sharing payments that qualify under Sec. 126 may be excluded from income reported by
farmers. Several federal and state programs have been certified under Sec. 126. They include the
Wetlands Reserve Program, NYS Agricultural Non-Point Pollution Grant Program, the NYC Watershed
Agricultural Program and other watershed protection programs. To be excluded, the payment must be
for capital expenditures such as concrete pads, storage tanks, tile drains, diversion ditches and manure
storage. Payments for items that can be expensed on Sch. F, including soil and water conservation
expenses, may not be excluded. A portion of a payment that increases annual gross receipts from the
improved property more than 10% or $2.50 times the number of effected acres may not be excludable.
All excluded Sec. 126 payments are subject to recapture as ordinary income to the extent that
there is gain upon sale of the property within 10 years of receiving the payment (IRC Sec. 1255). If the
property is sold in more than 10 and less than 20 years, a declining percentage of the excluded payment
is recaptured.
28
Conservation Reserve Payments (CRP)
Farmers enrolled in the CRP are compensated for converting erodible cropland to less intensive
use. They receive annual CRP rental payments that are ordinary income. Whether the payments are
Sch. F income subject to self-employment tax, or Sch. E or Form 4835 income not subject to selfemployment tax depends on the following conditions:
1) If the taxpayer receiving CRP payments is materially participating in a farming business that
includes the enrolled land, the CRP payments are Schedule F income. The 6th Circuit has reversed
the Tax Court (Wuebker) case, which had treated the CRP payments as non-self-employment
income to be reported on Schedule E.
2) If the taxpayer is a non-participating landlord and the taxpayer hires someone to manage the CRP
acreage, the payments are Schedule E income.
3) If the taxpayer was and is a non-materially participating crop-share lessor, before and after entering
the CRP, the payments are Form 4835 income.
The Wetlands Reserve Program (WRP)
Farmers and other landowners may be receiving permanent and/or non-permanent easement
payments for enrolling land in the WRP where its use is limited to hunting, fishing, periodic grazing,
haying, and managed timber production. Permanent easements may be a lump sum payment or range
from 5 to 30 annual payments. Non-permanent easement payments must be extended over 5 or more
years. Landowners participating in the WRP are also eligible for cost-sharing payments to restore the
land to a healthy wetland condition.
Granting a permanent easement results in the same tax consequence as selling development
rights. The taxpayer is allowed to reduce the entire basis in the underlying property before reporting
gain from the easement (Rev. Rul. 77-414). If the land has been held for more than one-year, the gain is
Sec. 1231 capital gain.
Example: True Wetland enrolls 100 acres under the WRP permanent easement option and
receives $500 per acre or $50,000. The basis of the 100 acres, purchased in 1955, is $20,000. True
reduces the basis to $0 and realizes a $30,000 capital gain.
Permanent easement payments spread over more than the first year should be reported as
installment sales. Since interest is not included in any current WRP contract it must be imputed and a
portion of each payment allocated to interest. The grantor of a discounted or bargain sale permanent
easement may be able to claim a charitable deduction for the difference between its value and the price
received.
Non-permanent easement payments are ordinary income unless the taxpayer accepts the position
taken by the American Farmland Trust and reports them the same as perpetual or permanent easement
payments. IRS and the tax court say the payments are ordinary income and if the taxpayer continues to
use the land in an associated farming or timber activity, they are included in self-employment income.
29
Cost-sharing payments under the WRP are eligible to be excluded under Sec. 126. Otherwise,
these restoration payments are reported as Sch. F income where they may be offset by the restoration
costs. If the taxpayer continues to farm, some or all of the cost-sharing payments may be deducted as
soil and water conservation expenses. Income and expenses associated with managing and maintaining
the WRP land are reported on Sch. F or C.
INCOME FROM CANCELLATION OF DEBT AND RECAPTURE AGREEMENTS
The tax code specifies that cancellation of debt, called discharge of indebtedness income (DII), is
ordinary income to the borrower. In many situations, the DII does not result in taxable income. In return
for not reporting the income, the taxpayer must reduce "tax attributes”, such as investment credit, net
operating losses and basis in assets which may result in tax liability for the taxpayer in future years.
Bankrupt and insolvent debtor rules
If canceled debt exceeds total tax attributes, the excess canceled debt is not reported as taxable
income. If cancellation of debt outside of bankruptcy causes a taxpayer to become solvent, the solvent
debtor rules must be applied to the DII equal to solvency.
Solvent farmer rules (debt discharged after 4-9-86)
Discharged debt (DD) must be “qualified farm indebtedness” which is debt incurred directly in
connection with the operation of the farm business. Additional “qualified farm indebtedness” rules are:
(1) 50% or more of the aggregate gross receipts of the farmer for the three previous years must have been
attributable to farming and (2) the discharging creditor must be (a) in the business of lending money and
(b) not related to the farmer, did not sell the property to the farmer and did not receive a fee for the
farmer’s investment in the property. These rules are quite restrictive and will prevent some solvent
farmers from using tax attributes to offset DII.
Solvent farmers must reduce tax attributes in exchange for not reporting DII as income. The basis
reduction for property owned by the solvent taxpayer must take place in the following order: (1)
depreciable assets, (2) land held for use in farming and (3) other property. The general rule that basis may
not be reduced below the amount of the taxpayer’s remaining debt does not apply under these special
solvent farmer rules. DII remaining after tax attributes have been reduced must be included in a solvent
farmer’s taxable income. If the DII exceeds the total tax attributes, all the tax attributes will be given up
and the excess of DII over the tax attributes will be included in income and may cause a tax liability.
Solvent and insolvent farmers receive little relief from gain triggered on property transferred in
settlement of debt. The difference between basis and FMV is gain regardless of the amount of DII. The
FMV is ignored for non-recourse debt and the entire difference between the basis of property transferred
and the debt canceled is gain or loss. Discharge of indebtedness is not includable in income if the
transaction is a purchase price reduction (IRC Sec.108(c)(5)).
30
Farm Service Agency (FSA) Recapture of Previously Discharged Debt
Some farm owners were required to give the FSA a shared appreciation agreement or a recapture
agreement in exchange for the discharge of debt. The agreement allows FSA (formerly FmHA) to
recapture part of the debt that was previously discharged if the farm is sold for more than the appraised
value at time of discharge. If the taxpayer treated the debt reduction as DII debt for tax purposes at the
time of the workout, then a FSA recapture will trigger a tax consequence. A typical appreciation
agreement would obligate the farmer to pay FSA the lesser of the excess of the amount received when
the farm is sold over the amount paid FSA under the agreement or, the difference between the FMV of
the farm at buyout and the amount paid under the agreement. When discharged debt is recaptured the
tax treatment of some DII, may need to be changed. The DII originally recognized as ordinary income
now becomes a deduction against ordinary income. DD offset by a reduction in attributes is added back
to the same attributes and DD not recognized under insolvency rules requires no adjustment.
LIKE-KIND TAX FREE (Deferred) EXCHANGES
Taxpayers may postpone recognition of gain on property they relinquish if they exchange that
property for property that is "like-kind." The gain is postponed by not recognizing the gain realized on
the relinquished property and reducing the basis in the acquired property. Both the relinquished
property and the acquired property must be used in a trade or business or held for investment [I.R.C.
Sec. 1031(a)(1)]. A summary of the rules [Reg. Sec. 1.1031(k)-1] follows:
Rules and Requirements
Generally, in order to have a deferred exchange, the transaction must be an exchange of
qualifying property. A sale of property followed by a purchase of a like-kind does not qualify for nonrecognition under Sec. 1031. Gain or loss is recognized if the taxpayer actually or constructively
receives money or non-like-kind property before the taxpayer actually receives the like-kind
replacement property. Property received by the taxpayer will be treated as property not of a like-kind if
it is not "identified" before the end of the "identification period" or the identified replacement of
property is not received before the end of the "exchange period".
The identification period begins the day the taxpayer transfers the relinquished property and ends
at midnight 45 days later. The exchange period begins on the day the taxpayer transfers the relinquished
property and ends on the earlier of 180 days later or the due date (including extensions) for the
taxpayer’s tax return. (If more than one property is relinquished, then the exchange period begins with
the earliest transfer date.)
Deferral of tax is also possible with reverse like-kind swaps (in which the seller acquires
replacement property before the original property is sold. Rev. Proc. 2000-37 outlines the very exacting
requirements that must be met for such swaps to qualify as like-kind exchanges.
Replacement Property
Replacement property is identified only if it is designated as such in a written document signed
by the taxpayer and is properly delivered before the end of the identification period to a person obligated
31
to transfer the property to the taxpayer. Replacement property must be clearly described in a written
document, (real property by legal description and street address, personal property by make, model, and
year). In general, the taxpayer can identify from one to three properties as replacement property.
However, there can be any number of properties identified as long as their aggregate FMV at the end of
the identification period does not exceed 200% of the aggregate FMV of all the relinquished properties
(the 200% rule). Identification of replacement property can be revoked in a signed written document
properly delivered at any time before the end of the identification period.
Identified replacement property is received before the end of the exchange period if the taxpayer
actually receives it before the end of the exchange period and the replacement property received is
substantially the same property as that identified. A transfer of property in a deferred exchange will not
fail to qualify for non-recognition of gain merely because the replacement property is not in existence or
is being produced at the time it is identified.
If the taxpayer is in actual or constructive receipt of money or other property before receiving the
replacement property, the transaction is a sale and not a deferred exchange. The determination of
whether the taxpayer is in actual or constructive receipt of money or replacement property is made
without regard to certain arrangements made to ensure that the other party carries out its obligation to
transfer the replacement property. These arrangements include replacement property secured or
guaranteed by a mortgage, deed of trust, or other security interest in property; by a standby letter of
credit as defined in the regulations; or a guarantee of a third party. It is also made without regard to the
fact that the transferee is secured by cash, if the cash is held in a qualified escrow account or trust.
Qualified Escrow Account and Intermediary
A qualified escrow account or trust is one in which the escrow holder or trustee is not the taxpayer or a disqualified person, and the taxpayer’s right to receive, pledge, borrow, or otherwise obtain
the benefits of the cash are limited until the transaction is closed.
A qualified intermediary (Q/I) is a person who is not the taxpayer or a disqualified person and
acts to facilitate the deferred exchange by entering into an agreement with the taxpayer for the exchange
of properties. A Q/I enters into a written agreement with the taxpayer, acquires the relinquished
property from the taxpayer, and transfers the relinquished property and the replacement property.
The taxpayer’s agent at the time of the transaction is a disqualified person. An agent is a person
who has acted as the taxpayer’s employee, attorney, accountant, investment banker or broker, or realestate agent or broker within the two-year period ending on the date of the transfer of the first of the
relinquished properties.
Real Property
For real property, "like-kind" is interpreted very broadly. Any real estate can be exchanged for
any other real estate and qualify for I.R.C. Sec. 1031 so long as the relinquished property was, and the
acquired property is, used in a trade or business or held for investment. Consequently, a farm can be
exchanged for city real estate and improved real estate can be exchanged for unimproved real estate.
32
Farm Business Personal Property
"Like-kind" is interpreted to mean, “like-class” for personal property. “Like-class”, means that
both the relinquished and replaced properties are in the same general asset class or same product class.
Most personal property used in a farm business is included in product class 3523 Farm
Machinery and Equipment. Farmers will generally qualify for I.R.C. Sec. 1031 treatment when they
exchange farm equipment for farm equipment. However, automobiles like general-purpose trucks,
heavy general-purpose trucks, information systems and other office equipment are all assigned to
separate general asset classes. Livestock of different sexes are not property of a like-kind but exchanges
of same sex livestock have qualified as tax free exchanges.
Other Deferred Exchange Rules and Requirements
IRS Form 8824 is used as a supporting statement for like-kind exchanges reported on other
forms, including Form 4797 (Sale of Business Property) and Schedule D (Capital Gains and Losses). A
separate Form 8824 should be attached to Form 1040 for each exchange. Form 8824 should be filed for
the tax year in which the seller (exchanger) transferred property to the other party in the exchange.
If the relinquished property is subject to depreciation recapture under I.R.C. Sec. 1245, 1250,
1252, 1254, and or 1255; part or all of the recapture may have to be recognized in the year of the likekind exchange. Any recapture potential not recognized in the year of the exchange will carryover as an
attribute of the asset received in the exchange.
IRS Announcement 2000-4 requires that, for property placed in service after January 2, 2000,
the basis of the traded item continue to be depreciated over the remaining recovery period of the old
property, using the same method and convention. Accumulated depreciation of the old asset would
carryover and potentially be subject to recapture upon the sale of the newly acquired asset. Any
additional cost basis would be treated as newly acquired property. This provision applies to all MACRS
property, but taxpayers that did not follow it prior to January 3, 2000 are not required to change
depreciation calculations. If they wish to change prior depreciation calculations, the procedure
described in the instructions for Form 3115 should be followed.
Like-kind exchanges between related parties can result in recognition of gain if either party
disposes of the property within two-years after the exchange.
DEPRECIATION AND COST RECOVERY
The standard depreciation rules for regular income tax have not changed except for the clarification
of MACRS calculations for items acquired with a trade-in (see previous section on Like-Kind
Exchanges, IRS Announcement 2000-4). AMT depreciation rules were modified in 1998 and will
reduce the depreciation adjustment for 1999 and years following. This reference is for practitioners and
taxpayers that want to apply depreciation rules to maximize after tax income. The modified accelerated
cost recovery system (MACRS) provides for eight classes of recovery property, two of which may be
depreciated only with straight line. MACRS applies to property placed in service after 1986. PreMACRS property continues to be depreciated under the ACRS or pre-ACRS rules. Most taxpayers will
33
be using MACRS, ACRS, and the depreciation rules that apply to property acquired before 1981. This
manual concentrates on the MACRS rules but some ACRS information is included. Additional
information on ACRS and pre-ACRS rules can be found in the Farmer’s Tax Guide.
Depreciable Assets
A taxpayer is allowed cost recovery or depreciation on purchased machinery, equipment, buildings,
and on purchased livestock acquired for dairy, breeding, draft, and sporting purposes unless reporting on
the accrual basis and such livestock are included in inventories. Depreciation must be claimed by the
taxpayer that owns the asset. A taxpayer cannot depreciate property that he or she is renting or leasing
from others. The costs of most capital improvements made to leased property may be depreciated by the
owner of the leasehold improvements under the same rules that apply to owners of regular depreciable
property. A lessor cannot depreciate improvements made by the lessee.
Depreciation or cost recovery is not optional. It should be claimed each year on all depreciable
property including temporarily idle assets. An owner who neglects to take depreciation when it is due
now has two opportunities to recover the lost depreciation. It may be recovered by filing an amended
return or by following a procedure for automatic change to a permissible accounting method for
depreciable property, Rev. Proc. 97-37. A correction procedure is also available to taxpayers whose
depreciation or amortization deduction claimed is more than the allowable amount (Rev. Proc. 97-27).
Form 3115 (Application for Change in Accounting Method) must be filed with the IRS by the end of the
tax year and a copy attached to the taxpayer's return for the tax year that the correction in depreciation is
made. A fee is required when too much depreciation has been claimed. Procedures 99-27 & 98-60
carry detailed, line-by-line instructions on how to complete Form 3115.
MACRS Classes
The MACRS class life depends on the asset depreciation range (ADR) midpoint life of the
property.
____________________________________________________________________________________
MACRS Class
3-year
5-year
7-year
10-year
15-year
20-year
ADR Midpoint Life
4 years or less
More than 4 but less than 10 years
10 or more but less than 16 “
16 or more but less than 20 “
20 or more but less than 25 “
25 or more other than 1250 property
with an ADR life of 27.5 years or more
-----------------------------------------------------------------------------------------------------------------------------27.5-year
Residential rental property
39-year (31.5 if acquired before 5/13/93)
Nonresidential real property
Assets are placed in one of the eight MACRS classes regardless of the useful life of the property
in the taxpayer’s business. Examples of the types of farm assets included in each MACRS class are
shown below.
34
Three-year property:
1.
Section 1245 property with an ADR class life of four years or less. This includes over-the-road
tractors and hogs held for breeding purposes. It does not include cattle, goats or sheep held for
dairy or breeding purposes because the ADR class life of these animals is greater than four years.
2.
Section 1245 property used in connection with research and experimentation. Few farmers will
have this type of property.
3.
Race horses more than two years old when placed in service and all other horses more than 12
years old when placed in service.
Five-year property:
1.
All purchased dairy and breeding livestock (except hogs and horses included in the 3 or 7-year
classes).
2.
Automobiles, light trucks (under 13,000 lbs. unladen), and heavy-duty trucks.
3.
Computers and peripheral equipment, typewriters, copiers and adding machines.
4.
Logging machinery and equipment.
Seven-year property:
1.
All farm machinery and equipment.
2.
Silos, grain storage bins, fences, and paved barnyards.
3.
Breeding or work horses (12 years old or less).
Ten-year property includes single purpose livestock and horticultural structures (seven-year property if
placed in service before 1989) and orchards and vineyards (15-year property if placed in service before
1989).
Fifteen-year property:
1.
Depreciable land improvements such as sidewalks, roads, bridges, water wells, drainage facilities
and fences other than farm fences (which are in the 7-year class). Does not include land
improvements that are explicitly included in any other class, or buildings or structural components.
2.
Orchards, groves, and vineyards when they reach the production stage if they were placed in
service before 1989.
Twenty-year property includes farm buildings such as general-purpose barns, machine sheds, and many
storage buildings.
27.5-year property includes residential rental property.
39-year (31.5 if acquired before 5/13/93) property includes nonresidential real property.
35
ACRS, MACRS and MACRS Alternative Depreciation System (ADS)
Recovery Periods for Common Farm Assets
Asset
Airplane
Auto (farm share)
Calculators, copiers & typewriters
Cattle (dairy or breeding)
Citrus groves
Communication Equipment
Computer and peripheral equipment
Cotton ginning assets
Farm buildings (general purpose)
Farm equipment and machinery
Fences (agricultural)
Goats (breeding or milk)
Grain bin
Greenhouse (single purpose structure)
Helicopter (agricultural use)
Hogs (breeding)
Horses (nonrace, less than 12 years of age)
Horses (nonrace, 12 years of age or older)
Logging equipment
Machinery (farm)
Mobile homes on permanent
foundations (for farm labor housing)
Office equipment (other than calculators,
copiers or typewriters) & furniture
Orchards
Paved lots
Property with no class life
Rental property (nonresidential real estate)
Rental property (residential)
Research property
Sheep (breeding)
Silos
Single purpose livestock structure (housing,
feeding, storage and milking facilities)
Single purpose horticultural structure
Solar property
Storage (apple, onion, potato)
Tile (drainage)
Tractor units for use over-the-road
Trailer for use over-the-road
Truck (heavy duty, general purpose)
Truck (light, less the 13,000 lbs.)
Vineyard
Water well
Wind energy property
*No class life specified. Therefore, 12-year life assigned.
**7 if placed in service before 1989.
***15 if placed in service before 1989.
****31.5 if placed in service before 5/13/93.
36
Recovery Period (Years)
ACRS
MACRS
5
5
3
5
5
5
5
5
5
15
5
7
5
5
5
7
19
20
5
7
5
7
3
5
5
7
5
10**
5
5
3
3
5
7
3
3
5
5
5
7
19
20
ADS
6
5
6
7
20
10
5
12
25
10
10
5
10
15
6
3
10
10
6
10
25
5
5
5
5
19
19
5
3
5
7
10***
15
7
39****
27.5
5
5
7
10
20
20
12
40
40
12*
5
12*
5
5
5
5
5
3
5
5
3
5
5
5
10**
10**
5
20
15
3
5
5
5
10***
15
5
15
15
12*
25
20
4
6
6
5
20
20
12*
Cost Recovery Methods and Options
Accelerated cost recovery methods for MACRS property are shown below. Depreciation on farm
property placed in service after 1988 is limited to 150% declining balance (DB) rather than the 200 %
available for nonfarm property. There are two straight-line (SL) options for the classes eligible for rapid
recovery. SL may be taken over the MACRS class life or the MACRS alternative depreciation system
(ADS) life. A fourth option is 150 % DB over the ADR midpoint life. The changes in depreciation
required for alternative minimum tax purposes are discussed in this section under Additional Rules and
in the Alternative Minimum Tax section.
Orchards and vineyards placed in service after 1988 are not eligible for rapid depreciation. They
are in the 10-year class and depreciation is limited to straight line.
Class
Most Rapid MACRS Method Available
3, 5, 7 and 10-year
Farm assets: 150 % DB if placed in service after 1988.*
200 % if placed in service 1987 through 1988.*
(See exception for orchards and vineyards above.)
Nonfarm assets: 200 % DB
with cross-over to SL
15 and 20-year
150 % DB
with cross-over to SL
27.5 and 39(31.5)-year
Straight line only
The MACRS law does not provide for standard percentage recovery figures for each year.
However, IRS and several of the tax services have made tables available.
Annual Recovery (Percent of Original Depreciable Basis)
(The 150% DB percentages are for 3, 5, 7 and 10-year class farm property placed in service after 1988.)
Recovery
Year
1
2
3
4
5
6
7
8
9
10
11
12-15
16
17-20
21
1
2
3-Year Class
200% 150%
DB
DB
33.33
25.00
44.45
37.50
14.81
25.00
7.41
12.50
5-Year Class
200% 150%
DB
DB
20.00 15.00
32.00 25.50
19.20 17.85
11.52 16.66
11.52 16.66
5.76
8.33
7-Year Class
200%
150%
DB
DB
14.29
10.71
24.49
19.13
17.49
15.03
12.49
12.25
8.93
12.25
8.92
12.25
8.93
12.25
4.46
6.13
10-Year Class
200%
150%
DB
DB
10.00
7.50
18.00
13.88
14.40
11.79
11.52
10.02
9.22
8.74
7.37
8.74
6.55
8.74
6.55
8.74
6.56
8.74
6.55
8.74
3.28
4.37
15-Yr.
Class
150%
DB
5.00
9.50
8.55
7.70
6.93
6.23
5.90
5.90
5.91
5.90
5.91
5.902
2.95
20-Yr.
Class
150%
DB1
3.75
7.22
6.68
6.18
5.71
5.29
4.89
4.52
4.46
4.46
4.46
4.46
4.46
4.46
2.24
Rounded to two decimals, see Pub. 946 for more precise 20-yr. class rates.
5.90 in years 12 & 14, 5.91 in years 13 & 15.
37
Half-Year and Mid-Month Conventions
MACRS provides for a half-year convention in the year placed in service regardless of the recovery
option chosen. A half-year of recovery may be taken in the year of disposal. No depreciation is allowed
on property acquired and disposed of in the same year. Property in the 27.5 and 39-year classes is
subject to a mid-month convention in the year placed in service.
Mid-Quarter Convention
If more than 40% of the year’s depreciable assets (other than 27.5 and 39-year property) are placed
in service in the last quarter, all of the assets placed in service during that year must be depreciated using
a mid-quarter convention. Assets placed in service during the first, second, third and fourth quarters will
receive 87.5, 62.5, 37.5 and 12.5% of the year’s depreciation, respectively. The amount expensed under
Sec. 179 is not considered in applying the 40% rule. In other words, the amount expensed under Sec.
179 can be taken on property acquired in the last quarter, which may help avoid the mid-quarter
convention rule.
Example: V. Sharp placed $102,000 worth of 7-year MACRS property in service. He could
expense $20,000 and claim $8,782 of depreciation ($102,000 - 20,000 = $82,000 x .1071 = $8,782)
under the half-year convention. If $52,000 of Sharp’s property was placed in service in the last quarter
and the $20,000 Sec. 179 election is applied to this $52,000, $32,000 is left to be used in the 40% test.
Thus, $32,000 ÷ ($102,000 - 20,000) = .39, which is less than 40%, so Sharp avoids the mid-quarter
rules. However, if his depreciable items had totaled $96,500 and $52,000 was placed in service in the
last quarter, he would be caught by the 40% rule, even if he applied the $20,000 Sec. 179 to the items
placed in service in the last quarter. That is, $32,000 ÷ ($96,500 - 20,000) = .42, and all the depreciation
items would be subject to the mid-quarter convention.
If the 40% rule is triggered, the depreciation on property acquired in the first and second quarters
actually increases. Taxpayers are not allowed to use the mid-quarter rules voluntarily. However, choice
of property to expense under Sec. 179 could work to the advantage of a taxpayer that wanted to become
subject to the rules. If third quarter property could be expensed and thereby have the 40% rule triggered,
the depreciation on first and second quarter property would be increased. Whether this increases total
depreciation for the year would depend on the proportion placed in service in each quarter.
MACRS Alternative Depreciation
The MACRS alternative depreciation system (ADS) is required for some property and is an option
for the rest. It is a straight line system based on the alternative MACRS recovery period (ADR midpoint
lives). Farmers who are subject to capitalization of pre-productive expenses, discussed later, may elect
to avoid capitalization, but if they do so, they must use the ADS life on all property.
Election to Expense Depreciable Property
The Section 179 expense deduction is $20,000 for property placed in service in 2000. It was
$19,000 for 1999. It increases to $24,000 in 2001 and $25,000 in 2003. The expense deduction is
phased out dollar for dollar for any taxpayer that places over $200,000 of property in service in any year,
with complete phaseout at $220,000. Eligible property is defined as Sec. 1245 property to which Sec.
168 (accelerated cost recovery) applies. Property must be used more than 50% of the time in the
38
business to qualify. General purpose buildings, property acquired from a related person, and certain
property leased by non-corporate lessors do not qualify. Excluded is property used outside the U.S.,
property used by tax exempt organizations, property used with furnished lodging, property used by
governments and foreigners, and air conditioning and heating units. When property is acquired by trade,
Sec. 179 deductions may not be claimed on the basis of the trade-in.
In the case of partnerships, the $20,000 limit applies to the partnership and also to each partner as
an individual taxpayer. A partner who has Sec. 179 allocations from several sources could be in a
situation where only $20,000 may be expensed because of the $20,000 limitation. Any allocations in
excess of $20,000 are lost forever, (which is a different result from the limitation discussed below). The
same concept applies to S corporations.
The amount of the Sec. 179 expense deduction is limited to the amount of taxable income of the
taxpayer that is derived from the active conduct of all trades or businesses of the taxpayer during the
year. Taxable income for the purpose of this rule is computed excluding the Sec. 179 deduction. Any
disallowed Sec. 179 deductions due to this taxable income limitation are carried forward to succeeding
years. The deduction of current plus carryover amounts is limited to $20,000 in 2000.
Section 179 regulations provide that wage and salary income qualifies as income from a trade or
business. Therefore, such income can be combined with income (or loss) from Schedules C or F in
determining income from the "active conduct of a trade or business" when calculating the allowable
deduction. Sec. 1231 gains and losses from a business actively conducted by the taxpayer are also
included.
Gains from the sale of Sec. 179 assets are treated like Sec. 1245 gains. The amounts expensed are
recaptured as ordinary income in the year of sale. The Sec. 179 expense deduction is combined with
depreciation allowed in determining the amount of gain to report as ordinary income on Part III of Form
4797.
If post-1986 property is converted to personal use or if business use drops to 50% or less, Sec. 179
expense recapture is invoked no matter how long the property was held for business use. The amount
recaptured is the excess of the Sec. 179 deduction over the amount that would have been deducted as
depreciation. The recapture is reported on Part IV of Form 4797 and then on Schedule F.
Every business owner who has purchased MACRS property should consider the Sec. 179 expense
deduction because only New York investment tax credit will be lost when it is used. It should not be
used to reduce AGI below standard (or itemized) deductions plus exemptions, unless an additional
reduction in self-employment tax is worth more than depreciation in a future tax year. Also, the
taxpayer must be sure not to use more Sec. 179 deduction than the amount of taxable income from the
"active conduct of a trade or business."
MACRS Property Class Rules
For 3, 5, 7, and 10-year MACRS property, the same recovery option must be used for all the
property acquired in a given year that belongs in the same MACRS class.
Example: A farmer purchased a tractor, harvester and combine in 2000. All belong in the 7-year
property class. The farmer may not recover the tractor over seven years with rapid recovery (150% DB)
39
and the other items over seven or ten years with SL. However, a taxpayer may choose a different
recovery option for property in the same MACRS class acquired in a subsequent year. For example, a
farmer could have chosen SL 10-year recovery for equipment purchased in 1998 (7-year property),
150% DB for seven years for equipment purchased in 1999, and could now select SL 7-year recovery
for all machinery purchased in 2000.
A taxpayer may select different recovery options for different MACRS classes established for the
same year. For example, a taxpayer could select fast recovery on 5-year property, straight line over
seven years on 7-year property, and straight line over 15 years on most 10-year property.
Some Special Rules on Autos and Listed Property
There are special rules for depreciation on vehicles and other "listed property". If used less than
100% in the business, the maximum allowance is reduced, and if used 50% or less, the Sec. 179
deduction is not allowed and depreciation is limited to SL. The maximum depreciation and Sec. 179
expense allowance for four-wheeled vehicles called “luxury cars” (6000 lbs. or less) placed in service in
2000 remains at $3,060 for the first year. The depreciation allowance has been reduced to $4,900 for the
2nd year, and remains at $2,950 for the 3rd year and $1,775 for each succeeding year. If the business use
percentage is less than 100%, these limits are reduced accordingly. Cellular telephones acquired after
1989 are listed property. Computers are listed property unless they are used only for business.
Additional Rules
For Sec. 1245 property placed in service after 1986 and before 1999, depreciation must be
recalculated for AMT purposes using the following table:
Sec 1245 Property Placed in Service Prior to 1999
Used for Regular Tax Purposes
Must Use for AMT Purposes
150 DB MACRS
200 DB MACRS
SL MACRS
ADS
150 DB, ADS life
150 DB, ADS life
SL, ADS life
ADS
The difference between regular depreciation and this re-determined amount is an income adjustment
subject to inclusion in alternative minimum taxable income. The AMT depreciation adjustment for Sec.
1250 property is the difference between what was claimed for regular income tax and that allowed under
MACRS ADS straight line depreciation. For Sec. 1250 property placed in service after 1998 (and also
for any property depreciated under the SL method) the AMT depreciation adjustment is eliminated. For
other property (Sec. 1245 property on which regular MACRS is used), the 150% DB MACRS method
must be used over the normal recovery period (not ADS life). Therefore, farm property placed in
service after 1998 is not subject to the AMT depreciation adjustment. An adjustment remains for
property placed on a 200% DB depreciation schedule.
MACRS rules allow half a year’s depreciation in the year of disposition if using the half-year
convention. If the mid-quarter convention applies, depreciation is allowed for the quarters held in the
year of disposition. Recovery may be claimed in the year of disposition (based on the months held in
that year) on 27.5 and 39-year property.
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When assets are sold, gain to the extent of all prior depreciation on all Sec. 1245; 3, 5, 7, 10 and 15year MACRS property is ordinary income. There is no recapture of depreciation on property in the 20year class if straight line recovery is used (see A Review of Farm Business Property Sales section).
Property placed in service during a short tax year is subject to special allocation rules that vary with
the applicable convention used. Details are provided in Pub. 534.
Choosing Recovery Options
Taxpayers will maximize after-tax income by using Sec. 179 and rapid recovery on 3, 5, 7, 10, and
15-year MACRS property, assuming the deductions can be used to reduce taxable income and do not
create an AMT adjustment that results in AMT liability. The taxpayer that will not be able to use all the
deductions in the early years may want to consider one of the straight line options.
Using straight line rather than 150% declining balance on 20-year property will preserve capital
gain treatment (at a 25% maximum rate), at the time of disposal. However, the tax savings will be
realized many years from now. For most taxpayers, the choice of the best recovery option for 20-year
MACRS property should be based on the value of concentrating depreciation in early years versus
spreading it out. The time value of money makes current year depreciation more valuable than that used
in later years. However, depreciation claimed to reduce taxable income below zero is wasted.
Reporting Depreciation and Cost Recovery
Form 4562 is used to report the Section 179 expense election, depreciation of recovery property,
depreciation of non-recovery property, amortization, and specific information concerning automobiles
and other listed property. Depreciation, cost recovery, and Sec. 179 expenses are combined on 4562 and
entered on Schedule F. However, partnerships and S corporations will transfer the Sec. 179 expense
election to Sch. K, Form 1065 rather than combining it with other items on 4562. Since depreciation is
excluded when calculating net earnings for self-employment on Sch. K and K-1, include it as an
adjustment to net farm profit on Sch. SE.
Uniform Capitalization Rules for Fruit Growers and Nurserymen
Plants subject to uniform capitalization rules include fruit trees, vines, ornamental trees and shrubs,
and sod providing the pre-productive period is 24 months or more. The pre-productive period begins
when the plant or seed is first planted or acquired by the taxpayer. It ends when the plant becomes
productive in marketable quantities or when the plant is reasonably expected to be sold or otherwise
disposed of. An evergreen tree, which is more than six years old when, harvested, (severed from the
roots), is not an ornamental tree subject to capitalization rules. Timber is also exempt. If trees and vines
bearing edible crops for human consumption are lost or damaged by natural causes, the non-depreciable
costs of replacing trees and vines do not have to be capitalized.
In Notice 2000-45, IRS has now provided the following list of commercially grown plants with
nationwide weighted average pre-productive periods in excess of 2 years: almonds, apples, apricots,
avocados, blackberries, blueberries, cherries, chestnuts, coffee beans, currants, dates, figs, grapefruit,
grapes, guavas, kiwifruit, kumquats, lemons, limes, macadamia nuts, mangoes, nectarines, olives,
oranges, papayas, peaches, pears, pecans, persimmons, pistachio nuts, plums, pomegranates, prunes,
raspberries, tangelos, tangerines, tangors, and walnuts.
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This is not an all-inclusive list. For other plants grown in commercial quantities in the U.S., the
nationwide weighted average pre-productive period must be determined based on available statistical
data. IRS says that it intends to update this guidance periodically as needed.
Fruit growers who choose to capitalize will need to establish reasonable estimates of the
preproductive costs of trees and vines. Nurserymen could use the farm-price method to establish their
preproductive costs of growing trees, vines, and ornamentals. Capitalization requires the recovery of
orchards, vineyard, and ornamental tree pre-productive period expenses over 10 years. If growers elect
not to capitalize, they must use alternative MACRS to recover the costs of trees and vines (20-year
straight line) and all other depreciable assets placed in service. Only the pre-productive period growing
costs may be expensed.
Accurate Records Needed
Accurate and complete depreciation records are basic to reliable farm income tax reporting and
good tax management. Depreciation and cost recovery must be reported on Form 4562. A complete
depreciation and cost recovery record is needed to supplement Form 4562. It is not necessary to submit
the complete list of items included in the taxpayer’s depreciation and cost recovery schedules.
GENERAL BUSINESS CREDIT
The General Business Credit is a combination of investment tax credit, work opportunity credit,
welfare-to-work credit, research credit, low-income housing credit, disabled access credit, plus others
(see following page). Form 3800 is used to claim the credit for the current year, to apply carryforward
from prior years, and claim carryback from later years. The credit allowable cannot reduce regular tax
below tentative AMT. It is also limited to $25,000 plus 75% of net regular tax liability above $25,000.
Special limits apply to married persons filing separate returns, controlled corporate groups, estates and
trusts, and certain investment companies and institutions (Sec. 46(e)(i)). TRA ’97 changed the
carryback period to one-year and the carryforward period to 20 years beginning in 1998. The three-year
carryback and 15-year carryforward rules remain for all credits earned before 1998.
Review of Federal Investment Credit
Federal investment tax credit (IC) was repealed for most property placed in service after 12/31/85.
IC may still be earned on rehabilitated buildings, qualified reforestation expenses, and certain business
energy investments. IC (Sec. 45(a)(1)) is 10% of the amount of qualified investment with more liberal
allowances for some rehabilitated historic buildings. IC is a direct reduction against income tax liability.
If it cannot be used in the year it is earned, it can be carried back and carried forward to offset tax
liability in other years. Unused investment credit from 1986 and earlier years, reduced by 35% may be
carried forward 15 years. Reforestation IC does not require the 35% reduction.
If property is disposed of before IC claimed is fully earned, the credit must be re-computed to
determine the amount to recapture. Recapture rules apply when there is early disposition of rehabilitated
buildings, business energy property and/or reforested land for which investment credit has been claimed.
The amount of recapture is 100% during the first year of service and declines to zero after five full years
of service. Form 3468 is used for computing IC, Form 4255 is used to recapture IC.
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Rehabilitated buildings (expenditures) credit is 10% for a qualified rehabilitated building and 20%
for a certified historic structure. The building (other than a certified historic structure) must have been
first placed in service before 1936. Expenditures for the interior or exterior renovation, restoration or
reconstruction of the building qualify for the credit. Costs for acquiring or completing a building, or for
the replacement or enlargement of a building, do not qualify. The credit is available for all types of
buildings that are used in a business. Buildings that are used for residential purposes do not qualify
unless they are certified historic structures that are used for residential purposes. The use of a building
is determined based on its use when placed in service after rehabilitation. Thus, rehabilitation of an
apartment building for use as an office building would render the expenditure eligible for credit. The
basis for depreciation must be reduced by 100% of the investment credit claimed. Expenditures must
exceed the greater of the adjusted basis of the property or $5,000.
Qualified reforestation expenses consist of up to $10,000 ($5,000 if married filing separately) of the
direct expenses of planting or replanting a forest or woodlot held for timber or wood production. Direct
expenses include site preparation, seedlings, labor, and depreciation of equipment used. These are the
same expenses that qualify for amortization. Deductible operating costs, all costs reimbursed through
government cost-sharing programs, and all costs associated with planting Christmas trees are excluded.
The basis of any depreciable reforestation expense must be reduced by 50% of IC claimed.
Business energy investment credit is equal to 10% of the basis of qualified solar and geothermal
energy equipment placed in service during the tax year. Active solar devices for either space heating or
water heating would qualify under the solar category if put to original use by the taxpayer. The basis of
any qualifying equipment must be reduced by 50% of IC claimed.
Other General Business Credits
Work opportunity credit (extended through December 31, 2001) is available to employers on first
year employee wages paid. First year wages paid targeted group employees with 120 to 400 hours of
service earn 25% credit. The credit increases to 40% when an eligible employee reaches or exceeds 400
hours. There are eight targeted groups including qualified SSI recipients, recipients of aid to families
with dependent children, (IV-A recipients), certain food stamp recipients, high risk youth living in
empowerment zones, economically disadvantaged ex-felons, and certain disabled workers and veterans.
Qualification rules were modified for IV-A recipients and veterans. The above rules include changes
effective for workers employed after September 1997.
Welfare-to-Work Credit is available to employers on qualified wages paid to long-term family
assistance recipients prior to January 1, 2002. The credit is 35% on qualified first year wages and 50%
on qualified second year wages. The credit applies to the first $10,000 of an eligible employees wage
each year for a maximum credit of $8,500 over two years. Wages include the value of benefits, health
insurance benefits and employer contributions, educational assistance and dependent care expenses.
In general, to qualify as long-term family assistance recipients, members of a family must have
been receiving family assistance for at least 18 months before the hiring date. The recipient must be
certified by a designated local agency as being a member of a family receiving assistance under a IV-A
program. Employers cannot get work opportunity credit and welfare-to-work credit on the same
employee.
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Research & Development Credit has a five-year extension to June 30, 2004, but July 1, 1999 to
September 30, 2000 credits can not be used until October 2000. Credits from October 2000 to
September 2001 are delayed until October 2001.
Disabled access credit may be claimed by an eligible small business that incurs expenses for
providing access to persons with disabilities. The credit is 50% of eligible expenses that exceed $250
but do not exceed $10,250. An eligible business is one that for the preceding year did not have more
than 30 full-time employees or did not have more than $1 million in gross receipts. An employee is
considered full-time if employed at least 30 hours per week for 20 or more calendar weeks in the tax
year.
Other general business credits: Low-income housing credit, alcohol fuels credit, enhanced oil
recovery credit, renewable electricity production credit, empowerment zone credit, Indian employment
credit and employer FICA tax credit on tips.
A REVIEW OF FARM BUSINESS PROPERTY SALES
The reduction in capital gains rates increases the spread between the regular marginal income tax
rate and the capital gain rate for all individual taxpayers. Since farm taxpayers will be affected by the
new capital gain rates and income averaging, tax planning and management of farm property sales has
increased in importance. The first step in tax planning is making the distinction amongst gains from
sales of property used in the farm business that are eligible for capital gain treatment, gains subject to
recapture of depreciation, and Schedule F income.
The reporting of gains and losses on the disposition of property held for use in the farm business
continues to be a complicated but an important phase of farm tax reporting. Form 4797 must be used to
report gains and losses on sales of farm business property. Schedule D is used to accumulate capital
gains and losses. The treatment of gains and losses on disposition of property used in the farm business
can be better understood after a review of IRS classifications for such property.
1.
Section 1231 - Includes gains and losses on farm real estate and equipment meeting a holding period
requirement. Also, see discussion below explaining that livestock must be held for dairy, breeding,
sport or draft to qualify as Sec. 1231 property. The required holding period is 24 months for cattle
and horses, 12 months for other qualified livestock, casualty and theft losses and other involuntary
conversions, qualified sales of timber, and unharvested crops sold with farmland which was held at
least one year. There are instances, however, when gain on livestock, equipment, land, buildings,
and other improvements is treated specifically under Section 1245, 1250, 1252, and 1255 (resulting
in a portion of these gains being treated as ordinary income).
Under Sec. 1231, net gains are treated as long-term capital gains but net losses are fully deductible
ordinary losses.
Note: Net Sec. 1231 gains are treated as ordinary income to the extent of unrecaptured net
Sec. 1231 losses for the five most recent prior years. A taxpayer that claimed a net Sec. 1231
loss on the 1995, 1996, 1997, 1998 or 1999 return and has a net Sec. 1231 gain for 2000 must
recapture the losses on the 2000 return (if they have not already been used against Sec. 1231
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gains in earlier years). Losses are to be recaptured in the order in which they occurred. Any
current year Sec. 1231 gains in excess of these prior year losses would still receive long-term
capital gains treatment.
2. Section 1245 - One of the depreciation recapture sections. Farm machinery, purchased dairy,
breeding, sport and draft livestock, held for the required period, and sold at a gain are reported under
this section. Gain will be ordinary income to the extent of depreciation and Sec. 179 expense
deductions. Gain to the extent of depreciation claimed on capitalized pre-production costs is also
reported here. Even if a taxpayer elects out of UCR and instead uses the ADS method of
depreciation, the pre-production costs that would have otherwise been capitalized must be recaptured
as ordinary income.
Single-purpose livestock and horticultural structures (placed in service after 1980) are Sec.
1245 property. Nonresidential 15, 18, and 19-year ACRS property becomes Sec. 1245
property if fast recovery (regular ACRS) has been used. Other tangible real property
including silos, storage structures, fences, paved barnyards, orchards and vineyards is Sec.
1245 property.
3.
Section 1250 - Farm buildings and other depreciable real property held over one-year and sold at a
gain are reported in this section unless the assets are Sec. 1245 property. If other than straight line
depreciation was used, the gain to the extent of depreciation claimed after 1969 that exceeds what
would have been allowed under straight line depreciation is recaptured as ordinary income. No
recapture takes place when only straight line depreciation has been used. A taxpayer may shift such
real property to straight line depreciation without special consent.
Gain to the extent of SL depreciation on Sec. 1250 assets sold after May 6, 1997, is called
unrecaptured Sec. 1250 gain and is taxed at a maximum rate of 25%.
General purpose farm buildings (including house provided rent-free to employees) placed in service
after 1986 are MACRS 20-year property eligible for 150% DB depreciation. Depreciation claimed
that exceeds straight line must be recaptured as ordinary income when the buildings are sold. A
different MACRS option may be used on a substantial improvement to the original building. If fast
recovery has been used on either the building or a substantial improvement to it, gain will be
recaptured on the entire building to the extent of fast recovery. Any remaining gain will be capital
gain. For residential rental real estate, gain will be recaptured only to the extent that fast recovery
deductions exceed straight line on 15, 18, and 19-year property.
An illustration of taxation of gain on Sec. 1250 property. A general purpose farm building was
purchased in 1998 for $20,000. Regular MACRS was used until the building was sold for $23,000
in 2000. Accumulated depreciation totaled $2,861. Total gain was therefore $5,861. SL
depreciation would have been $2,000 so excess depreciation of $861 would be recaptured as
ordinary income. The gain due to SL depreciation would be taxed at a maximum rate of 25%. The
$3,000 of gain resulting from the sale price exceeding the original cost would be subject to long
term capital gains rates (10% or 20%).
4.
Section 1252 - Gain on the sale of land held less than 10 years will be part ordinary and part capital
gain when soil and water conservation expenditures have been expensed. If the land was held five
years or less, all soil and water or land clearing expenses taken will be "recaptured" as ordinary
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gain. If the land was held more than five and less than 10 years, part of the soil and water expenses
will be recaptured. The percentages of soil and water conservation expenses subject to recapture
during this time period are: 6th year after acquisition of the land, 80%; 7th year, 60%; 8th year,
40%; and 9th year, 20%.
Here is an illustration:
Farmland acquired, April 1, 1994 cost
Soil and water expenses deducted
on 1995 tax return
Land was sold May 15, 2000 for
$100,000
$8,000
$130,000
During the time the land was owned, no capital improvements were made other than the soil and
water expenses, so the adjusted tax basis at time of sale was $100,000. The gain of $30,000 would
normally be all capital gain. The land was held for six years, so the gain is divided; $8,000 x .80 =
$6,400 is ordinary gain and $30,000 - $6,400 = $23,600 qualifies for capital gains treatment.
5.
Section 1255 - If government cost sharing payments for conservation have been excluded from
gross income under the provisions of Sec. 126, the land improved with the payments will come
under Sec. 1255 when sold. All the excluded income will be recaptured as ordinary income if the
land has been held less than 10 years after the last government payment had been excluded.
Between 10 and 20 years, the recapture is reduced 10% for each additional year the land is held.
There is no recapture after 20 years.
Use of Form 4797 and Schedule D by Farmers
All sales of farm business properties are reported on Form 4797 to separate Sec. 1231 gain and loss
from recapture as ordinary gain such items as depreciation, cost recovery, Section 179-expense
deduction and basis reduction (due to business credits). Casualty and theft gains and losses are reported
on Form 4684 and transferred to Form 4797.
If the Sec. 1231 gains and losses reported on Form 4797 result in a net gain, net Sec. 1231 losses
reported in the prior five years must be recaptured as ordinary income by transferring Sec. 1231 gain
equal to the non-recaptured losses to Part II. Any remaining gain is transferred to Schedule D and
combined with capital gain or loss, if any, from disposition of capital assets. If the Sec. 1231 items
result in a net loss, the loss is combined with ordinary gains and losses on Form 4797 Part II and then
transferred to Form 1040.
Livestock Sales
The majority of livestock sales from Northeast farms are animals that have been held for dairy,
breeding or sporting purposes. Income from such sales is always reported on Form 4797. Dairy cows
culled from the herd and cows held for dairy or breeding purposes are the most common of these sales.
Sales of horses and other livestock held for breeding, draft or sporting purposes also go on Form 4797.
46
Income from livestock held primarily for sale is reported on Schedule F. Receipts from the sale of
"bob" veal calves, feeder livestock, slaughter livestock, and dairy heifers raised for sale are entered on
Schedule F, line 4. Sales of livestock purchased for resale are entered on line 1 of Schedule F, and for a
cash basis farmer the purchase price is recovered in the year of sale on line 2. The intent of holding
livestock is a key issue in determining if sales are reported on 4797 or Schedule F.
Dairy, Breeding, Sport or Draft Livestock
Dairy cattle raised or purchased to replace or add to the taxpayers herd are held for dairy purposes.
Dairy cattle that are raised or purchased and developed as breeding stock to be sold to other farmers are
held for sale. Livestock held for dairy, breeding, sport or draft purposes are classified into two groups
according to length of holding periods:
1. Cattle and horses held two years or more, and other breeding livestock held one-year or more.
Animals in this group are Sec. 1231 livestock and these holding periods were not changed by TRA
’97 or RRA’98. Emus and ostriches are currently excluded from the IRS definition of Sec. 1231.
2. Cattle and horses held less than two years and other breeding livestock held less than one-year.
These sales do not meet holding period requirements.
Most dairy animals will meet the two-year holding period requirement. Major exceptions are raised
young stock sold with a herd dispersal and the sale of cows that were purchased less than two years prior
to sale. The age of raised animals sold will determine the length of the holding period. The date of
purchase is needed to determine how long purchased animals are held. The holding period begins the
day after the animal is born or purchased and ends on the date of disposition.
Reporting Sales of Sec. 1231 Livestock
Sales of Sec. 1231 livestock are entered in Part I or Part III of Form 4797. Since Part III is for
recapture, purchased Sec. 1231 livestock that produce a gain when sold are be entered in Part III where they
become Sec. 1245 property. Sales of raised animals on which costs were capitalized are also reported in
Part III, as are animals on which pre-productive costs would have been capitalized if the taxpayer had not
“elected out” during the years when livestock were required to be capitalized (1987-1988). Sales of raised
Sec. 1231 livestock not subjected to the capitalization rules that are held for dairy, breeding, sport or draft
purposes are entered in Part I. All purchased Sec. 1231 livestock (held the required holding period) that
result in a loss when sold is also entered in Part I.
Reporting Sales of Livestock Not Meeting Holding Period Requirements
Dairy, breeding, sport or draft livestock that are not held for the required period whether sold for a
gain or loss will be entered in Part II of 4797. This will include raised cattle that are held for dairy or
breeding but sold before they reach two years of age and purchased cattle held for dairy or breeding but
held for less than two years.
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Summary of Reporting Most Common Farm Business Property Sales
Type of Farm Property
Tax Form and Section
1. Cattle and horses held for dairy, breeding, sport or draft
purposes & held for 2 years or more; plus
other breeding or sporting livestock held for at least one-year:
a) Raised, pre-productive costs not subject to
capitalization rules (1231 Property)
b) Purchased (and raised subject to capitalization
rules), sale results in gain (1245 Property)
c) Purchased (and raised subject to capitalization
rules), sale results in loss (1231 Property)
2. Livestock held for dairy, breeding, sport & draft,
purposes but not held for the required period.
3. Livestock held for sale.
4797, Part I
4797, Part III
4797, Part I
4797, Part II
Schedule F, Part I
4. Machinery held for one-year or more:
a) Sale results in gain
b) Sale results in loss
4797, Part III
4797, Part I
5. Buildings, structures & other depreciable real property
held for one-year or more:
a) Sale results in gain
b) Sale results in loss
4797, Part III
4797, Part I
6. Farmland, held for one-year or more
sold at a gain:
a) Soil & water expenses were deducted or cost
sharing payments excluded
b) If 6a does not apply
7. Machinery, buildings, other depreciable real property
& farmland held for less than one-year.
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4797, Part III
4797, Part I
4797, Part II
INSTALLMENT SALES
The installment method of reporting may still be used by cash basis taxpayers (who are nondealers) for the sale of real property or personal property (except for the gain caused by depreciation
recapture). Note however that accrual basis taxpayers are prohibited for using the installment method on
sales after December 16, 1999 (Tax Relief Extension Act of 1999, which is currently being debated). It
continues to be a practical and useful method used in transferring farms to the next generation. The
installment method is required when qualified property is sold and at least one payment is received in
the following tax year unless the seller elects to report all the sale proceeds in the year of disposition.
Taxable income from installment sales is computed by multiplying the amount received in any year
by the gross profit ratio. The gross profit ratio is gross profit (selling price minus the total of adjusted
tax basis and recapture gains ineligible for installment reporting) divided by contract price (selling price
less mortgage assumed by buyer plus any mortgage assumed in excess of adjusted tax basis). Form
6252 is used to report installment sales income. IRS Pub. 225 contains a chapter on installment sales.
Depreciation Recapture
Recaptured depreciation does not qualify for installment sale reporting. That portion of the gain
attributed to recaptured depreciation of Sec. 1245, 1250 and 1252 property must be excluded from
installment sale reporting. Sec. 179 expenses and capitalized expenditures also are subject to Sec. 1245
recapture. The full amount of recaptured depreciation is reported as ordinary income in the year of sale
regardless of when the payments are received.
Example: Frank Farmer sells his raised dairy cows, machinery and equipment to son, Hank, for
$180,000. The cows are valued at $80,000, the machinery at $100,000. Hank will pay $30,000 down
and $30,000 plus interest for five years. Frank’s machinery and equipment has an adjusted basis of
$45,000; its original basis was $125,000. The raised cows have zero basis. Frank’s gain on the sale of
machinery and equipment is $55,000 ($100,000 - $45,000). The full $55,000 is recaptured depreciation
since prior depreciation, $80,000, is greater. Frank must report $55,000 received from machinery in the
year of sale. He will report the $80,000 cattle sales gain on the installment method.
When the sale of Sec. 1245 and 1250 property produces gain in addition to that which is
recaptured, the amount of recaptured depreciation reported in the year of sale is added to the property’s
basis to compute the correct gross profit ratio. This adjustment must be made to avoid double taxation
of installment payments.
Related Party Rules (IRC Sec. 453)
The installment sale/resale rules should be reviewed before farmers or other taxpayers agree to a
sales contract. Gain will be triggered for the initial seller when there is a second disposition by the
initial buyer, and the initial seller and buyer are closely related. (Closely related persons would include
spouse, parent, children, and grandchildren, but not brothers and sisters.) The amount of gain
accelerated is the excess of the amount realized on the resale over the payments made on the installment
sale. Except for marketable securities, the resale recapture rule will not generally apply if the second
sale occurs two or more years after the first sale and it can be shown that the transaction was not done
49
for the avoidance of federal income taxes. The two-year period will be extended if the original
purchaser’s risk of loss was lessened by holding an option of another person to buy the property.
In no instance will the resale rule apply if the second sale is also an installment sale where
payments extend to or beyond the original installment sale payments. Also exempt from the resale rule
are dispositions (1) after the death of either the installment seller or buyer, (2) resulting from involuntary
conversions of the property (if initial sale occurred before threat or imminence), (3) non-liquidating
sales of stock to an issuing corporation.
An additional resale rule prevents the use of the installment method for sales of depreciable
property between a taxpayer and his or her partnership or corporation (50% ownership), and a taxpayer
and a trust of which he or she (or spouse) is a beneficiary. All payments from such a sale must be
reported as received in the first year and all gains are ordinary income (IRC §453(g) and 1239).
Use of Escrow Accounts
The installment method may be disallowed if the seller and buyer use an escrow account to hold all
or part of the sale proceeds for payment in a future year. Deposits into an irrevocable escrow account
are payment in full, unless a substantial restriction exists on the seller’s ability to receive the funds (Rev.
Rul. 77-295 & 79-91). Tax courts have been more liberal and have allowed the use of escrow accounts
where the arrangement is part of a bona fide, arms-length agreement between buyer and seller, no
interest from escrowed funds is received by the seller and the escrow agent does not act under the
exclusive authority of the seller.
Rule Changes from TRA’97
Farmers may use the installment method of accounting for AMTI from the disposition of property
used or produced in farming (see Alternative Minimum Tax). Manufacturers of tangible personal
property will not be able to use the installment method to report income from sales to their dealers in tax
years beginning after August 5, 1998.
General Rules Still in Effect
Losses cannot be reported on an installment sale. A partnership may use the installment sale
method of reporting gain on the sale of partnership property even though an individual partner may have
a loss and recognize it in the year of sale.
The capital gains rules in effect when an installment payment is received and reported determines
how the income is treated. However, a change or increase in the capital gain holding period requirement
during an installment sale would not move a long-term gain to a short-term gain.
A sale or exchange of an installment sale contract results in a gain or a loss. The gain or loss is the
difference between the "amount realized" and the "basis" of the contract. The "amount realized" is the
amount received by the seller, including fair market value of property received instead of cash. The
"basis" of the contract is the same as the remaining basis of the underlying property.
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A cancellation of all or part of an installment obligation is treated like a sale or other disposition of
the obligation except gain or loss is calculated as the difference between the fair market value and the
"basis" of the obligation if the parties are unrelated (IRC Sections 453B(f)(1) and 453B(a)(2)).
Grain and other farm inventory property, including livestock held for sale, may be included in a
cash basis taxpayer’s installment sale and it no longer requires an AMT adjustment in the year of sale.
Unstated and Imputed Interest Rules
If the installment sale contract does not provide an adequate interest rate (the Applicable Federal
Rate), part of the principal payment must be treated as interest income by the seller and an interest
deduction by the buyer. The amount of interest that must be recognized is called imputed interest. The
imputed interest rule applies even if the seller elects out of the installment method or has a loss on the
sale. When recharacterization of the loan is required, the seller’s interest income increases and capital
gain decreases.
Imputed interest rules applicable to certain debt instruments including installment sales are covered
under IRC Section 1274 and Section 483. There are several special rules and numerous exceptions that
complicate the understanding and application of imputed interest rules.
1.
2.
3.
4.
5.
All sales and exchanges where seller financing does not exceed $3.96 million (indexed) must have
an interest rate of the lesser of 100% of the applicable federal rate (AFR) or 9% (compounded
semiannually).
Sales exceeding $8 million (indexed estimate) are subject to an imputed interest rate equal to 100%
of the AFR. All sale-leaseback transactions are subject to rates equal to 110% of AFR.
The sale or exchange of the first $500,000 of land between related persons, (brothers, sisters,
spouse, ancestors or lineal descendants) in one calendar year, must have a test or stated rate of 6%
compounded semiannually or the AFR.
The imputed interest rules do not apply to the sale of personal use property, annuities, patents, and
any other sale that does not exceed $3,000.
Imputed as well as stated interest may be accounted for on the cash accounting method on sales of
farms not exceeding $1 million and any other installment sale not exceeding $250,000.
The AFR can be the current month’s rate or the lower of the two preceding months’ rates.
Recent Applicable Federal Rates (AFR)
Term
Compounding Period
Short-term (<3 yrs.)
Mid-term (3-9 yrs.)
Long-term (>9 yrs.)
Source:
Sept. ’00
Oct. ’00
Annual
6.33%
6.30%
Monthly
6.15%
6.12%
Annual
6.22%
6.09%
Monthly
6.05%
5.93%
Annual
6.09%
5.96%
Monthly
5.93%
5.80%
http://www.irs.ustreas.gov/prod/ind_info/index.html
Nov. ’00*
* Not available at press time
51
LEASING OF LAND AND OTHER FARM ASSETS
Production Flexibility Contract (PFC) Payments on Leased Land
The 1996 Farm Bill provides PFC payments to landowners and tenants based on the crop acreage
base for the leased land. In general, these PFC payments are divided between the landowner and the
lessee according to their respective share of the crop produced. This bill may induce many landowners
to shift from a cash rent arrangement to a share lease, to be able to share in the government payments. If
the landowner begins to materially participate, then it will affect the landowner’s self-employment taxes
and social security benefits, as the income would be reported on Schedule F. If the landowner does not
meet any one of the material participation tests (Farmers Tax Guide, Pub. 225) then they can report their
share of the crop on Form 4835 rather than as cash rent on Sch. E and still not be subject to SE taxes.
Rental Income and Deductions (IRC Sec. 1402(a)(1))
Generally, rental income from real estate and from personal property leased with the real estate
(including crop share rents) is reported on Sch. E and not included in net earnings from selfemployment. Crop and livestock share rents are reported on Form 4835 and flow through to Sch. E.
However, there are two exceptions, the second of which is very important to farm operators:
1.
Rentals received in the course of the trade or business of a real estate dealer are included in net
earnings from self-employment.
2.
Production of agricultural or horticultural commodities. Income derived by the owner or tenant of
land is included in net earnings from self-employment if:
a. There is an arrangement between the taxpayer and another person under which the other
person produces agricultural or horticultural commodities on the land and the taxpayer is
required to participate materially in the production or the management of the production of
such commodities, and/or
b. There is material participation by the taxpayer with respect to the agricultural or horticultural
commodity.
The IRS (with support from the Tax Court and the 8th Circuit Court) has taken the position that rent
received by a taxpayer for land rented to a partnership or corporation in which the taxpayer materially
participates is subject to self-employment tax. (That is, the material participation of the entity
arrangement is “wrapped into” the lease arrangement.) Working for wages as an employee of the farm
operation has also been considered as part of the overall “arrangement”, making the rental payments
paid to the employee/landowner subject to self-employment tax. The language of this IRC §1402
appears to exclude rents paid on farm buildings and improvements, from self employment tax even if
there is an overall arrangement found to be providing for material participation.
52
Income and expenses from the rental of personal property (not leased with real estate) is reported
on Schedule C or C-EZ. Net profit from Schedule C is included in self-employment income. Material
participation is not a factor in classifying income from the rental of personal property that is not leased
with real estate.
Paying Rent to a Spouse It is common for husbands and wives to own farm real estate as joint tenants,
for one to operate the farm as the sole proprietor and to pay self-employment tax on the entire farm "net
profit." Paying rent to a spouse for use of the property he or she owns might reduce self-employment
tax.
Although Rev. Rul. 74-209, 1974-1 allows an operator to deduct rent paid to a spouse as a joint
owner of business property equal to one-half its fair rental value, more recent IRS rulings and opinion
have qualified that ruling. IRS indicated the deduction for spousal rent is allowable only if there is a
bona fide landlord-tenant relationship and that substance rather than form governs. Note also the issue
discussed above, which could cause the rental income to be subject of self-employment tax if the spouse
is an employee of the farm and the arrangement can be construed collectively as providing for material
participation.
Strategy If a sole proprietor deducts rental payments made to a spouse for use of his or her jointly
owned property, or a farm entity pays land rent to one of its owners, the following precautions are
suggested:
(1) make sure there is a formal, written, signed, rental agreement and a fair market value rental rate
for buildings separate from farm land, with at least annual payments;
(2) deduct the taxes, interest, and insurance on the rented property on the owner’s Schedule E;
(3) if a spouse, the spouse should deposit the rental income in a separate account and pay his or her
tax and interest payments from the account;
(4) the farm operator must file Form 1099 for all rent payments made;
(5) the landowner should avoid material participation.
Note: An IRS determination that land rent is self-employment income due to material participation from
an overall arrangement would not only cause additional self-employment tax to be paid but could also
affect eligibility for Social Security benefits of those landowners collecting benefits prior to age 65.
The farm operator’s spouse cannot avoid material participation for purposes of the passive activity
rules. The participation by a spouse (operator) is treated as participation by the taxpayer. Consequently,
any income derived from the property in which he or she materially participates is not treated as passive
activity income.
53
Valid Tax Lease or Conditional Sales Contract
To determine if an agreement is a lease or a sales contract, one needs to look at the intent, based
upon the facts and circumstances in the agreement. Generally, an agreement will be a conditional sales
contract rather than a lease for tax purposes if any of the following are true:
a) The agreement applies part of each payment toward equity interest.
b) The lessee gets title to the property upon payment of a stated amount under the contract.
c) The amount the lessee pays for a short period of time is nearly the amount that would have to be
paid to buy the property.
d) The lessee pays much more than the current fair rental value of the property.
e) The lessee can purchase the property at a nominal price compared to the value of the property at
the time of purchase.
f) The lessee has the option to buy the property at a nominal price compared to the total amount
the lessee has to pay under the lease.
g) The lease designates part of the payments as interest or part of the payments is easy to
recognize as interest.
The most common lease arrangement today is the leverage lease of newly purchased equipment
where a large portion of the purchase price is financed with a loan that is fully amortized by lease
payments from the lessee. These leases are used for automobiles, trucks, computers, equipment, etc.
IRS will accept these transactions as a valid lease if all the following conditions are met.
1) When the lessee places the property in use, the investment of the lessor must be at least 20% of the
cost of the property.
2) The lease term includes all renewal or extension periods at fair rental value at the time of the renewal
or extension.
3) No lessee may purchase the property at a price less than its fair market value when exercised.
4) Lessee may furnish none of the cost of the property.
5) The lessee may not lend to the lessor any of the money or guarantee indebtedness to acquire the
property.
6) The lessor must expect to receive a profit from the transaction.
For cash method taxpayers, the allowable deduction for prepaid lease payments, as a general rule, is
limited to the taxable year for the months expired. In the case of Zaninovich vs. Comm. the Court of
Appeals ruled that if an expenditure results in the creation of an asset having a useful life that extends
substantially beyond the close of the tax year, then that expenditure may not be deductible or may be
deductible only in part, for the taxable year made. The Court of Appeals adopted the “one-year rule”
which treats an expenditure as a capital expenditure (buildings, machinery and equipment) if it creates
an asset or secures a like advantage to the taxpayer and has a useful life in excess of one-year. On the
other hand, an expenditure can be deducted in full if the benefit of the payment does not exceed oneyear e.g. cash rent.
54
ALTERNATIVE MINIMUM TAX (AMT)
The AMT is a separate but parallel tax system. Its purpose is to impose a minimum tax on highincome taxpayers with so many deductions, exemptions, and credits that their regular income tax is very
low or zero. AMT may be created by adding back certain deductions and exemptions used to compute
the regular tax, and by disallowing most tax credits.
TRA ’97 included some AMT relief as well as new concerns for taxpayers. The relief provisions
reduced the capital gain rates and some major AMT exclusions (see explanation below). However more
taxpayers may be subject to AMT as personal deductions and non-refundable credits increase.
Four changes in AMT Affect Farmers
1. Effective for tax years ending after May 6, 1997 the lower 10%, 20% and 25% capital gain rates
used when computing regular taxes are also used to compute AMT on net capital gains. Prior to
TRA ’97 net capital gains were taxed at the standard 26% or 28% AMT rate. A technical
correction included in RRA ’98 reordered the formula used to compute the AMT capital gain tax
so that the lowest available rate is used first.
2. AMT depreciation for personal property has changed to a maximum rate of 150% declining
balance over the applicable MACRS recovery period for property placed in service after
December 31, 1998. The ADS requirement has also been repealed for depreciable real property
(Sec. 1250). Farmers will be able to use regular tax depreciation for AMT within the limits of
the effective date. Non-farmers who use 200% decline balance depreciation for regular tax will
still be required to make an AMT depreciation adjustment. Farmers will likely continue to have
adjustments for property placed in service prior to 1999 (as well as on assets acquired with trades
after 1998 due to differences between regular tax basis and AMT basis on the trade item).
3. Cash basis farmers may use the installment method for reporting sales of inventory or property
held primarily for sale to customers in the ordinary course of business in computing AMTI. This
provision is retroactively effective for tax year’s beginning after 1987. Therefore, qualified
farmers are eligible to use the installment sale method for deferred payment contracts in
computing AMT and regular income tax. Deferred payment contracts must avoid constructive
receipts to defer income to the following year.
4. Corporations with a three-year average annual gross receipts of less than $5 million will be
exempt from AMT for tax year’s beginning after December 31, 1997 (increasing to $7.5 million
for any later year).
Other AMT Changes
The AMT exemption for children under age 14 has been increased to the child’s earned income
plus $5,200 for 2000 ($5,350 for 2001). This amount is indexed for inflation. The annual exemption
can not exceed $33,750. The parent’s AMTI or AMT exemption will no longer be used to determine the
child’s AMT exemption.
55
AMT depreciation for pollution control facilities placed in service after December 31, 1998 may be
computed using MACRS class lives and the SL method. Prior to TRA ’97 longer ADS lives were
required.
AMT Rate and Exemption Phaseout
The AMT has a two-tiered 26 and 28% rate system for non-corporate taxpayers. The 26% rate
applies to the first $175,000 of AMTI ($87,500 for married filing separately) in excess of the exemption.
The 28% rate begins at $175,000 of AMTI. The exemptions are not indexed and are phased out at a rate
of 25% of AMT income exceeding specific levels, as shown in the table below. If the taxpayer’s AMTI
exceeds the exemption, he or she will have a calculated AMT but will pay AMT only if it exceeds the
regular tax.
Alternative Minimum Tax Exemption and Phaseout
Filing Status
Joint & qualifying widow(er)
Single & heads of household
Married filing separately
Maximum
Exemption
AMTI
Phaseout Range
$45,000
33,750
22,500
$150,000-330,000
112,500-247,500
75,000-165,000
Phaseout
Percent
25
25
25
Alternative Minimum Taxable Income (AMTI)
AMTI is calculated on Form 6251 by starting with 1040 taxable income before subtracting personal
exemptions. Any NOL carryforward used in calculating the regular tax is added and itemized
deductions disallowed on Schedule A for higher income taxpayers are now allowed.
Adjustments and Preferences. The first category below contains adjustments treated as "exclusions".
AMT due to exclusion items are not eligible for a credit against the following year’s regular tax. The
remaining adjustments are deferral items and are used in computing AMT credit in future years.
1.
Exclusion items: Standard deduction or certain itemized deductions from Schedule A, including
most medical deductions, miscellaneous deductions subject to the 2% rule, state and local taxes, and
interest adjustments. Interest adjustments include the difference between qualified housing interest
and qualified residence interest, interest income on private activity bonds that are exempt from
regular tax, and a net investment interest adjustment that could be either positive or negative.
Preferences treated as exclusion items include certain carryovers of charitable contributions, taxexempt interest from specified private activity bonds and excess tax depletion allowances.
2.
The depreciation adjustment is the net difference between accelerated MACRS depreciation and
that allowed for AMT. The Sec. 179 deduction is allowed in calculating AMTI. (See additional
rules in Depreciation and Cost Recovery Section.) Exceptions include property depreciated under
the unit-of-production method and property subject to transition rules for MACRS.
3.
Adjusted gain or loss from dispositions reported in Forms 4797, Sch. D and 4684 that have a
different basis for AMT than for regular tax (due to the accumulated depreciation adjustment).
56
4.
Incentive stock option adjustments, passive activity adjustments, AMTI from estates and trusts, taxexempt interest from private activity bonds.
5.
Accelerated depreciation on real and leased property and amortization of certified pollution control
facilities placed in service before 1987.
6.
Other adjustments may be required for intangible drilling costs, long-term contracts, certain loss
limitations, mining costs, patron’s distributions, pollution control facilities, research and
experimental costs and tax shelter farm activities.
Related Adjustments. Any item of income or deduction for a regular tax purpose that is based on
income (e.g., earned income, AGI, modified AGI or taxable income from a business) must be
recalculated based on alternative tax AGI.
Alternative Tax Net Operating Loss Deduction (ATNOLD)
The deduction of ATNOLD is the last step in calculating alternative minimum taxable income. The
alternate tax net operating loss is limited to 90% of AMTI and is calculated and deducted after all
adjustments and preferences have been added in. The ATNOLD is calculated the same as the regular
NOL except:
1.
The regular tax NOL is adjusted to reflect the adjustments required by the AMT rules.
2.
The ATNOLD is reduced by the preference items that increased the regular tax NOL.
Form 1045 (Application for Tentative Refund) can be used to calculate the ATNOLD providing the
above exceptions are included.
Tentative Minimum Tax
The minimum tax exemption reduced by the 25% phaseout is subtracted from AMTI before the
26% and 28% rates are applied. Taxpayers with net capital gains from Sch. D apply the appropriate
capital gains rates by completing Part IV of Form 6251. Then the AMT foreign tax credit is subtracted
to arrive at tentative minimum tax. A taxpayer who has regular foreign tax credit will compute AMT
foreign tax credit in much the same manner, using a separate Form 1116 (Foreign Tax Credit).
Alternative Minimum Tax and Credits
Tentative minimum tax less the regular income tax equals AMT. Regular income tax excludes
several miscellaneous taxes, such as the tax on lump-sum distributions. Regular income tax is reduced
by the foreign tax credit (but not business tax credits) before it is entered on Form 6251. The general
business credit limitation is calculated on Form 3800, not on 6251.
Foreign tax credit is allowed in the calculation of AMT. The Ticket to Work and Work Incentives
Act of 1999 provided some relief to taxpayers for tax years beginning in 2000 and 2001, by permitting
the personal nonrefundable credits (such as the education credits) to offset both the regular tax and the
minimum tax.
The other credits, including investment credit, can be carried forward to the extent they do not
provide a current year tax benefit because of the AMT.
57
Who Must File Test
More taxpayers are required to file Form 6251 than have an AMT liability. Form 6251 must be
filed if the tax on AMTI reduced by the exemption amount exceeds the taxpayer’s regular tax. If the
total of preference items is negative, Form 6251 should be filed to show the IRS that the taxpayer is not
liable for AMT. Also, if any credits are limited by tentative AMT, Form 6251 must be filed.
The AMT Credit
The AMT credit allows a taxpayer to reduce regular income tax to the extent that deferral
adjustments and preferences created AMT liability in previous years. The AMT credit also includes any
credit for producing fuel from a non-conventional source that was disallowed in an earlier year due to
AMT. The credit means that the taxpayer, in the long run, will not pay AMT on the deferral items.
Part I of Form 8801 (Credit for Prior Year Minimum Tax) is used to compute the AMT that would
have been paid in the previous year on the exclusion items if there had been no deferral items. This
requires the computation of a minimum tax credit net operating loss deduction, which is calculated like
the ATNOLD except that only the exclusion adjustments and preferences are included. It also requires
computation of the minimum tax foreign tax credit on the exclusion items.
Part II of Form 8801 is used to compute the allowable minimum tax credit and the AMT credit
carryforward. The computation includes unallowed credit for producing fuel from a non-conventional
source, orphan drug, and electric vehicle credit.
INFORMATIONAL RETURNS
Informational Forms (often issued or received by farmers)
1099-MISC - Must be filed by any person engaged in a trade or business, on each non-employee
paid $600 or more for services performed during the year. Rental payments, prizes, awards, and fish
purchases for cash must also be reported when one individual receives $600 or more and royalties at $10
or more. Payments made for non-business services and to corporations are excluded. When payments
of $600 or more are made to the same individual for independent services and merchandise, payments
for the merchandise can be excluded only if the contract and bill show that a determinable amount was
for the merchandise.
Farmers must include payments made to non-corporate independent contractors, attorneys,
accountants, veterinarians, crop sprayers, and repair shops. Payments made to corporate and noncorporate attorneys of $600 or more must be reported. Payments made for feed, seed, fuel, supplies, and
other merchandise are excluded.
Any person engaged in a trade or business must report aggregated payments of $600 or more to
physicians and health care providers. Also, Form 1099 is required if the taxpayer withheld federal
income tax on miscellaneous income under the back up withholding rules.
58
For corporations, only substitute payments in lieu of dividends, medical and healthcare payments
and attorney fees need to be 1099 reported.
1099-G - Report of agricultural program payments, discharge of indebtedness by federal government, state tax refunds, unemployment compensation, and qualified state tuition program payments.
1099-INT- Statement for Recipients of Interest Income. Filed by bankers and financial institutions
when interest paid or credited to individual taxpayers is $10 or more, and by any taxpayer if in the
course of a trade or business $600 or more of interest is paid to a non-corporate recipient.
1099-PATR - Taxable Distributions Received from Cooperatives. Must be filed for each patron
receiving $10 or more.
1099-S - Report payments of timber royalties under "pay-as-cut" contracts and gross proceeds from
the sale or exchange of most real estate transactions that consists in whole or in part of the exchange of
money, indebtedness, property, or services. The sale or exchange includes any transaction even if the
transaction is not currently taxable like a gain under IRC 1031.
Sellers of a principal residence can be exempted from receiving a 1099-S if the responsible person
at closing obtains written certification (sample wording in Rev. Pro. 98-26) from the seller(s) that the
gain is not reportable.
Note:
1) If any part of the residence has been used for business during the two-year period proceeding
the sale a Form 1099-S is required.
2) Box 5 on Form 1099-S reports the buyer’s share of real estate taxes on a personal residence. If
no Form 1099-S is required the tax allocation is included in the seller’s affidavit.
8300 - Recipient reports cash transactions of over $10,000 received in the course of a trade or
business, within one year in one lump sum or in separate payments, from the same buyer or agent, in a
single or related transaction. Cash includes all currency and specific monetary instruments with a value
of less than $10,000 (cashier’s checks, bank drafts, traveler’s checks, and money orders). The report
must be filed within 15 days after receiving $10,000.
8308 - Partnership reports the sales or exchange of partnership interest involving unrealized
receivables or substantially appreciated inventory items.
8809 - Request extension of time to file informational returns with IRS.
Filing Dates and Penalties
The 1099’s must be furnished to the person named on the return on or before January 31 and to the
IRS with Form 1096 (Annual Summary and Transmittal) on or before February 28. There is a failure to
file timely returns, single penalty of $15 per information return, if filed by March 30th (30 days late)
59
with a $25,000 cap for small businesses. This penalty increases to $30 per return if filed between March
30th and August 1st with a $50,000 cap for small businesses. Returns filed after August 1st or never filed
have a $50 penalty per return and a $100,000 cap for small businesses. The penalties are waived if the
taxpayer can demonstrate that the Form 1099 error or late filing was due to reasonable cause, and not to
willful neglect.
There is a mandatory requirement to use magnetic media or electronic filing if the client has 250 or
more informational returns. Taxpayers who ignore this requirement face a $50 penalty per
informational return. Waivers for this requirement must be requested on Form 8508, 45 days in advance
of the due date of the return.
SOCIAL SECURITY TAX AND MANAGEMENT SITUATION, AND OTHER PAYROLL TAXES
Annual increases in the earnings subject to social security (FICA) and self-employment taxes
continue to place a high priority on exploring opportunities to reduce the burden of these taxes through
wise tax management.
The Current Social Security Tax
The social security earnings base increased to $76,200 for 2000. There is no cap on the amount of
earnings subject to Medicare tax. FICA and self-employment tax percentage rates remain the same as in
1999. The total rate is divided into two components representing the social security and Medicare tax.
The maximum 2000 social security tax is $4,724.40 (employer’s share), up $223.20 from 1999.
Social Security Tax Table
Earnings Base
FICA Rate %1
Year
Soc. Sec.
Medicare
Soc. Sec.
1999
$72,600
Unlimited
6.20
1.45
12.40
2.90
2000
$76,200
Unlimited
6.20
1.45
12.40
2.90
2001
$80,1002
Unlimited
6.20
1.45
12.40
2.90
1
2
Medicare
Self-Employment Rate %
Soc. Sec.
Medicare
Paid by both employer and employee.
Projected
Employers use separate social security and Medicare tax withholding tables. Forms 941 and 943
require social security and Medicare taxes to be reported separately. The self-employment tax on long
Schedule SE is also computed separately.
Two Deductions for Self-Employed
1.
Self-employed taxpayers deduct from taxable income, on line 27 Form 1040, one-half of selfemployment taxes that can be attributed to a trade or business. The rationale for this tax deduction
is that employees do not pay income taxes on the one-half of FICA taxes paid by their employer.
2.
Self-employed taxpayers deduct 7.65% from self-employment income when computing net
earnings from self-employment. This is achieved by multiplying total profit (or loss) from
60
Schedules C and/or F by 0.9235 on Schedule SE. This adjustment is made before applying the
social security and Medicare tax earnings base. Taxpayers reporting less than $76,200 of selfemployment income will receive the greatest benefit from the deduction. This adjustment is
allowed because employees do not pay social security tax on the value of their employer’s share of
FICA tax.
Farmer’s Optional Method
Low-income farmers may still use the optional method and report up to $1,600 of self-employment
income when net farm income is less than $1,733. Self-employed non-farmers have a similar option.
Self-employed workers should give serious consideration to using the optional method if they are not
currently insured under the social security system. To be eligible for social security disability benefits, a
worker must be fully insured and have 20 of the last 40 quarters of coverage. The earnings required to
receive one quarter of credit increased to $780 in 2000. Thus, the optional method will yield only two
quarters of coverage. Earning $3,120 any time during 2000 will net four quarters of coverage.
Wages Paid to Spouse, Children and Farm Workers
Farm employers must pay FICA taxes and withhold income taxes on their employees if they pay
wages of more than $2,500 to all agricultural labor during the year. Any employee receiving $150 or
more of wages is subject to FICA and tax withholding even if the employer’s total annual payroll is less
than $2,500. All employees are covered if the annual payroll exceeds $2,500. Seasonal farm piece
work labor is exempt from the $2,500 rule providing the employee is a hand harvester, commutes to the
job daily from a permanent residence, and was employed in agriculture for less than 13 weeks in the
prior year. Seasonal farm piecework labor is subject to the $150 rule. The $150 test is applied
separately by each employee.
Wages earned by a person employed in a trade or business by his or her spouse and wages paid to
individuals 18 years old and over working for their parent(s) in a trade or business are subject to FICA
taxes and income tax withholding. Children under age 18 working for a parent’s partnership,
corporation, or estate also are covered by social security. Sole proprietors and husband-wife
partnerships that hire their children less than 18 years old needn’t pay social security tax on them nor
FUTA if under 21. Wages paid by a parent to a child for domestic service in the home are not covered
until the child reaches 21.
Payment of Agricultural Wages with Commodities
In some instances farmers and workers can reduce the amount of FICA taxes paid by paying wages
in the form of grain, livestock or other commodities. It may not always be to the employee’s advantage
to reduce FICA taxes since social security benefits may also be reduced when disabled or retired.
In 1994, for the benefit of examiners, taxpayers and practitioners, IRS issued guidelines with a
fairly narrow interpretation of I.R.C. Sec. 3121(a)(8)(A). The two factors used to determine whether a
bona fide transfer of in-kind compensation has occurred are Dominion and Control.
Remember even if the non-cash wages are ruled exempt from FICA, FUTA and income tax
withholding, they are still subject to income taxes. When farm commodities are used to pay employees
for services, the employer must report the fair market value of the commodity on the date of payment as
Schedule F income. The same amount is claimed by the employer as a labor expense on Schedule F, but
it is not reported as a social security wage on Form 943 or the employee’s W-2. It is included as other
compensation in box 1 of Form W-2 but not in box 3 and 5.
61
Employees who receive commodities in lieu of wages must report their initial market value as wage
income. When the commodities are sold, the sale price is reported on Schedule D, less the basis, which
is the initial market value plus storage and marketing expenses. If the employee is a farmer or dealer,
then they would use Schedule F or C respectively to report the commodities sold.
Taxation of Social Security Benefits
Social security recipients are potentially subject to two sets of rules on taxation of social security
benefits. Disability benefits are treated the same way as other social security benefits. The rules that tax
50% of social security benefits have been in effect for several years. The rules that tax up to 85% of
social security benefits for higher-income taxpayers became effective in 1994. Under a U.S. and
Canadian agreement signed in 1997 and retroactive to January 1, 1996, U.S. or Canadian SS benefits are
taxed exclusively in the country where the recipient resides. This will result in a higher tax for some
recipients and refunds for others.
The 85 Percent rules apply to single taxpayers, HH, and married filing separately with provisional
incomes above $34,000 and married taxpayers filing jointly with provisional incomes above $44,000.
Provisional income is modified AGI plus 50% of social security benefits. Modified AGI is AGI plus
tax-exempt interest and certain foreign source income.
For taxpayers with provisional incomes above these thresholds, gross income includes the lesser of:
1. 85% of the taxpayer’s social security benefit, or
2.
the sum of 85% of the excess of the taxpayer’s provisional income above the applicable threshold
amount plus the smaller of:
a. the amount of social security benefit included under previous law or
b. $4,500 ($6,000 for married taxpayers filing jointly).
For married taxpayers filing separately, gross income will include the lesser of 85% of social
security benefits or 85% of provisional income. (In other words, the threshold is $0.)
Example 1: His and Her Taxpayers have the following 2000 income:
Taxable interest and dividends
Tax-exempt interest
$9,000
6,000
Taxable pensions
30,000
Social security benefits
16,000
Provisional income = $9,000 + 6,000 + 30,000 + (1/2 x 16,000) = $53,000. Taxable portion of social
security benefits is the lesser of:
1.
85% of $16,000 social security benefits = $13,600; or
2.
the sum of 85% of the excess of $53,000 over $44,000, which is $9,000 x .85 = $7,650 plus the
smaller of:
a. 1/2 of $16,000 = $8,000 or
b. $6,000.
So 2.a. = $7,650 + 8,000 = $15,650;
2.b. = $7,650 + 6,000 = $13,650.
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Therefore, the social security benefit included in gross income = $13,600, which is the smallest of
1, 2.a. or 2.b. In this example, 85% of social security benefits are included in income.
Example 2: Same as Example 1 except that the taxable pensions, taxable interest and dividends, and
tax-exempt interest each is $2,000 less.
Provisional income = $7,000 + 4,000 + 28,000 + 8,000 = $47,000. Taxable portion of social security
benefits is the lesser of:
1. 85% of $16,000 social security benefits = $13,600, or
2.
the sum of 85% of the excess of $47,000 over 44,000, which is $3,000 x .85 = $2,550 plus the
smaller of:
a. 1/2 of $16,000 = $8,000; or
b. $6,000.
So 2.a. = $2,550 + 8,000 = $10,550;
2.b. = $2,550 + 6,000 = $8,550.
Therefore, the social security benefit included in gross income = $8,550, which is the smallest of 1, 2.a.
or 2.b. In this example, 53.4% of social security benefits are included in income.
The 50 percent rules apply to single taxpayers with provisional incomes between $25,000 and
$34,000 and married persons filing jointly with provisional incomes between $32,000 and $44,000. For
taxpayers in these ranges, the inclusion is still limited to the lessor of (1) one-half of the benefits
received, or (2) one-half of the excess of the sum of the taxpayer’s adjusted gross income, interest on
tax-exempt obligations, and half of the social security benefits over the base amount. ($32,000 for
persons filing jointly, $0 for married persons filing separately but living together, and $25,000 for all
others.) Medicare payments are excluded from gross income.
Example: Me and You Retiree received $15,200 in 2000 social security benefits, $3,000 of taxexempt interest, and their AGI (joint return) was $26,400 (excluding social security).
Calculation: a. $26,400 + $3,000 + $7,600 (one-half social security) = $37,000
b. $37,000 - $32,000 (base amount) = $5,000 ÷ 2 = $2,500.
c. Me and You include $2,500 since it is less than $7,600.
Reduction of Benefits
When a person’s wage and self-employment earnings exceed the earnings limit, social security
benefits of the working beneficiary and dependents are reduced by a percentage of the excess earnings.
In 2000 the annual earnings limit for those less than age 65 is $10,080, and for those age 65 to 70
earnings are now unlimited due to 2000 legislation. For those aged 70 and older there are also no
reductions. The reduction of benefits is one-half of excess earnings when less than age 65. The 2000
cost of living increase in benefits was 2.4%. The maximum monthly social security benefit for a worker
retiring at age 65 in January 2000 was $1,433. The average of all workers was $804 and couples $1,348
where both are receiving benefits.
Retirement Plan Considerations
Although the earnings cap for those workers over 65 that are getting social security benefits was
eliminated as of January 2000, those under 65 still have to stay under $10,080 in earnings in 2000 to not
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have a reduction benefits due to earnings. Usually work done prior to drawing benefits, but paid later
does not affect benefits. Commissions, sick pay, vacation pay, bonuses and carry over crops might fall
in to the category to not be counted in earned income for social security, but are taxable for federal tax
purposes. The rules for carry over grain sales made by retiring farmers are:
The sales are excluded from reducing social security benefits if both 1) the grain was produced
and in storage before or during the first month of benefits, 2) the grain is sold in the first year after
beginning to draw benefits. Remember that this carry over grain sale must be reported on schedule F
and schedule SE.
“Nanny Tax” Social Security Domestic Employment Act
This act allows the payment of employment taxes for domestic workers (baby-sitters, yard workers,
house cleaners) to be reported on the employer’s income tax return. The wage threshold for reporting
and paying social security taxes was raised to $1,200 annually. During 2000, you can give your
employee as much as $65 a month for expenses to commute to your home by public transportation
without the repayment counting as cash wages.
Household employers use Schedule H (Form 1040) to report and pay social security, Medicare,
FUTA (threshold still $1,000), and withheld income taxes. The quarterly return Form 942 is no longer
used. Farmers may treat wages paid to domestic workers under the new $1,200 annually threshold rules
rather than the $150 and $2,500 agricultural wage thresholds, by filing Schedule H.
Household employers must include an employer identification number (EIN) on forms they file for
their employees, like Forms W-2 and Sch. H. An EIN can be obtained by completing and filing Form
SS-4, Application for Employer Identification Number. Order Form SS-4 by calling 800-TAX-FORM.
The 1995 law exempted household workers under the age of 18 from any social security and
Medicare taxes unless household employment is the worker’s principal occupation.
Schedule H (Form 1040)
Taxpayers must file Schedule H if any of the following conditions apply:
(a) They paid any one household employee cash wages of $1,200 or more in 2000.
(b) They withheld Federal Income Tax during 2000 at the request of any household employee.
Preparers Election For Alternative Identification Numbers
In 1998 IRS approved an alternative to preparers including their own social security number on
prepared returns. In 2000, a preparer may apply for an alternative ID number (PTIN) on Form W-7P.
The number, when issued will begin with a “P” followed by 8 digits with no dashes. A New York
income tax representative indicated that the State would be also honoring the PTIN.
Rules for Depositing FICA and Federal Income Taxes
IRS changed the de minimis threshold from $500 to $1,000 for filing of monthly employment tax
returns. A new deposit threshold applies to quarterly Form 941 effective July 1, 1998 and January 1,
1999 for Form 943. However, under the new de minimis rule, if the total amount of accumulated
employment taxes for a period is less than $1,000 and it is deposited with a timely filed return for the
period it will be considered a timely deposit.
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IRS announced that small businesses would not be forced to invest in technology to make tax
payments. They raised the threshold for mandatory use of Electronic Federal Tax Payment System
(EFTPS) to $200,000 in aggregate deposits beginning January 1, 2000. They also again waived
penalties for not using EFTPS through December 31, 1999, while simultaneously raising the
participation level to $200,000 in aggregate 1998 deposits.
As of press time of this bulletin, there still remains EFTPS proposed changes see Pub. 15 Circular E. If
required to comply a taxpayer should use Form 9779 to enroll in EFTPS and at least a 14-week leadtime is required.
Federal Unemployment Tax (FUTA)
As farm businesses grow in size and employ more workers, more farm employers become subject to
FUTA. and New York unemployment insurance (UI). A farm employer must pay UI if (1) cash wages
of $20,000 or more were paid to farm employees in any calendar quarter during the current or preceding
calendar year, or (2) employ ten or more farm workers on at least one day in each of 20 different weeks
during that year or the preceding calendar year, or (3) as of the first day of the calendar quarter in which
they pay any remuneration to agricultural labor if they are also liable under FUTA for the same. IRS
Pub. 51 Circular A and NYS-50, contain useful information on how FUTA applies to an individual farm
employer.
The Federal Unemployment Tax Act exemption for alien agricultural workers has been made
permanent for alien agricultural workers admitted to the U.S. to do agricultural work.
The employer must pay unemployment taxes; they may not be deducted or withheld from employee
wages. The FUTA rate is 6.2% on the first $7,000 of cash wages paid to each employee in 2000. The
2000 NYSUI rates range from 0 to 8.5% on the first $8,500 of each employee’s total earnings. The
standard and maximum basic rate is 5.4%. The 2000 "new employer" rate is 4.4%. Employers may
receive a credit of up to 5.4% for NYSUI taxes paid on their FUTA liability even when their NYS
experience rate is less than 5.4%. A farmer subject to the NYSUI may pay a FUTA rate as low as 0.8%
in 2000. Beginning, April 1,1999 wage reporting was used to determine unemployment benefit rates.
The FUTA tax deposit rule is different from those for other payroll taxes. When the amount
subject to deposit reaches $100, it must be deposited within one month following the close of the current
calendar quarter. Form 940 (or 940-EZ) is the annual FUTA return to be filed by January 31.
Exception: FUTA taxes ($1,000 threshold) withheld from household employees are deposited with
FICA and income taxes on Schedule H (Form 1040).
NEW YORK STATE INCOME TAX
The 2000 New York State Budget Bill was passed on May 15, 2000. Many of the income tax changes
have effective dates after the 2000 tax year. The tax highlights of the 2000 legislation are:
•
The governor signed legislation expanding exemption from State and local sales and use taxes for
certain property and services used or consumed predominantly in farm production. This also
extends to commercial horse boarding operations. Effective September 1, 2000 a vendor that
accepts a completed valid Form ST-125 Certificate will not have to collect sales tax from the
purchaser. The definition of farming includes aquaculture, silviculture and commercial horse
boarding operations. Exemptions include tangible personal property, computers, building materials,
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machinery or equipment and services. See NYS Department of Taxation & Finance TSB-M-00(8)s
September 13, 2000 for further details.
•
Beginning in 2000 and thereafter, taxpayers with NYAGI of $25,000 or less will be allowed a NYS
child and dependent care (CADC) credit of 110% of the federal CADC credit. The credit is phased
down from 110% to 20% of the federal credit for NYAGIs between $25,000 and $65,000.
•
Beginning in 2002, the earned income tax credit (EITC) allowed is increased from 25% of the
federal credit to 27.5% and up to 30% in years after 2002.
•
The marriage penalty is reduced by gradually raising the standard personal income tax deduction for
married couples filing jointly or a surviving spouse from $13,000 to $14,600. Beginning in 2001,
the standard deduction is $13,400 and gradually increasing to $14,600 for taxable years beginning
after 2002.
•
A New York personal income tax college tuition deduction or credit will be phased in for college
tuition expenses up to $10,000 annually. Starting in 2001, 25% of such expenses may be deducted.
The full deduction will be available in tax year 2004 and thereafter. For taxpayers who do not
itemize there will be a refundable personal income tax credit phased in.
Farm Property School Tax Credit
This tax relief program has been in effect since 1997 and is usually modified annually. For the
2000 tax year, NY taxpayers whose federal gross income from farming equals at least two-thirds of
excess federal gross income, will be allowed a credit against personal income tax or corporation
franchise tax equal to school property taxes paid on certain agricultural property (personal residence
excluded). The allocation between personal residence plus other nonqualified property and agricultural
property should be made based upon taxable value. Your local assessor may be willing to provide this
information for you. Gross income from farming includes gross farm income from Sch. F, gross farm
rents Form 4835 and gains from livestock Form 4797. It also includes gross income from farming from
a partnership, S corporation, estate or trust. The NY tax credit limitation is based on school taxes paid
on qualified agricultural property plus 50% above the base acreage. The 2000 base acreage is 250 acres.
If a taxpayer’s farmland acreage exceeds the base acreage, the school taxes paid credit is scaled back in
proportion to the sum of the base acreage and 50% of the acreage in excess of the base.
The credit is claimed against NY State personal income tax, corporate franchise tax, S corp or
LLC income tax liabilities. Refunds can be claimed or carried over. Qualified agricultural property is
land located in New York State, which is used for agricultural production. The credit is not allowed for
the lessee, as the operator must be the owner of the leased land. Lessors of farmland may or may not
qualify dependent upon their qualifications as farm taxpayers. If agricultural property is converted to
non-qualified use, no credit is allowed that year and recapture is triggered for the previous two taxable
years.
Subsequent budget bills made some changes in definitions that made more farmers eligible.
Effective after the 1997 tax year, NY taxpayers whose federal gross income from farming equals at least
two-thirds of excess federal gross income will be allowed the school property tax credit. Excess federal
gross income is federal gross income from all sources for the taxable year in excess of a special $30,000
subtraction. The special $30,000 subtraction can be earned income (wages, salaries, tips and items of
gross income included in computation of net earnings from self employment), pension payments (SS),
interest and dividends. For 1998 and thereafter, the federal gross income of a corporation may, likewise,
be reduced by up to $30,000 for the special subtraction. A special ruling, for this section of law,
includes gross income from the production of maple syrup and cider, and from the sale of wine from a
licensed farm winery, in the term federal gross income from farming.
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If the modified New York adjusted gross income of the taxpayer exceeds $100,000 the credit is
phased out and completely lost at $150,000. Modified NY adjusted gross income is the NY gross
income for the taxable year reduced by the principal paid on farm indebtedness during the tax year.
Farm indebtedness is the debt incurred or refinanced that is secured by farm property, where the
proceeds of the debt are used for expenditures incurred in the business of farming.
Effective for taxable years on or after January 1, 1999, the Farmer’s School tax credit was
expanded to farmers who pay school taxes under a “land sales contract”. This means an eligible farmer,
under a land sales contract will be treated as the owner of the property if:
•
The buyer is obligated under the contract to pay the school property taxes on the land, and
•
The buyer is entitled to deduct these taxes as a tax expense for federal income tax purposes.
If the buyer is treated like the owner under these provisions, the seller may not claim the credit for
the property. An arrangement for a “lease with an option to purchase” is not a land sales contract.
For tax years beginning on or after January 1, 2001, the definition of qualified agricultural property
has been expanded to include set aside or retired acres under a federal supply management or soil
conservation program. (Note: this amendment confirms existing Tax Department policy.) In addition,
for the same tax years stated above the “base acreage” for computing the credit may be increased by
acreage enrolled or participating in an acreage reserve program pursuant to title three of the Federal
Agricultural Improvement and Reform act of 1996.
The Federal Tax Benefit Rule is “if you recover an amount that you deducted or took a credit for in
an earlier year, include the recovery in your income only to the extent the deduction or credit reduced
your tax in the earlier year” (Pub 525 Taxable and Nontaxable Income). Many questions are asked
about what to do with the Farmers School Tax Credit when IT-201, line 21 additions, explanation A22,
tells taxpayers to include the amount of the credit claimed for the prior year and use it as an addition to
income. Most taxpayers had already included it as other income on Schedule F and now were faced
with the same amount being taxed twice on the state form. Research on the federal taxability of Farmers
School Tax Credit indicated it was covered under the benefit rule. Letter Ruling 8435055 states under
sect 111 of the code, gross income for Federal income tax purposes includes recoveries of previously
deducted prior taxes to the extent that prior deductions resulted in an income benefit for the year of the
deduction. The term “prior taxes” includes previously deducted state or local property and/or income
taxes. Further rulings include Letter Ruling 8813029, Revenue Ruling 78–194, Letter Ruling 9853018,
and memorandum dated 9/28/84.
New York State Department of Taxation and Finance instructions now indicate “do not make this
modification if you were required to report the amount of the credit (farmers school tax) as income on
your 2000 Federal Return”.
New York State School Tax Relief (STAR)
This program provides a partial exemption from school property taxes for owner-occupied primary
residences. Senior citizen property owners must be 65 years of age or older, as of December 31, 2001
(advancing one-year annually) provide their latest available federal or state income tax return not to
exceed $60,000 adjusted gross income reduced by any distributions from an IRA or individual
retirement annuity. The “enhanced” STAR senior citizen exemption is a $50,000 exemption from the
full value of their property. The eligible senior citizen must apply with the local assessor for the
“enhanced” STAR exemption by March 1, 2001 in most towns. This is the “taxable status date” but
deadlines vary so most taxpayers should apply earlier.
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Previously to qualify for the enhanced exemption all owners must have satisfied the age
requirement except the spouse of a 65-year-old owner. For the 2001–2002 school year for residential
property owned by siblings, only one of the owners must be 65 years of age. Likewise, in the case of
property owned by a husband and wife, one of whom is at least 65, the exemption will not be rescinded
solely on death of the older spouse if the surviving spouse is at least 62 years old.
There were two important changes signed into law in 2000 to benefit STAR participants.
Beginning with the 2000 school year homeowners applying for the first time, for the basic exemption no
longer have to wait an additional year for the school tax bill, after the taxable status date. Also, people
who were denied the enhanced STAR exemption either because they did not apply before turning age 65
or because they were not aware of the 1999 legislation changing the date a taxpayer must be 65 can file
for the lost exemption based upon the previous year’s assessment rolls.
The “basic” STAR program is available to all primary residence homeowners regardless of age.
The full value assessment exemption is phased in from $10,000 to $30,000 by the school year 2001-02.
To be eligible an owner must own and live in a one, two or three-family residence, mobile home,
condominium, cooperative apartment or farm house. Under recent legislation the exemption, for
persons with disabilities and limited incomes, is subtracted from assessed value before subtracting the
STAR exemption.
STAR Property Tax Exemption Table
School Year
1998-99
1999-00
2000-01
2001-02 and after
Eligible Senior Citizen Homeowners
$50,000
$50,000
$50,000
$50,000
All Primary Residence Homeowners
None
$10,000
$20,000
$30,000
NY Tuition Savings Program
A taxpayer may contribute up to $5,000 per year exempt from New York personal income tax to a
family tuition account to be used for higher education expenses at qualified institutions. Married
individuals can each contribute up to $5,000 each year, but must each use a separate account. These
contributions are subtracted from a taxpayers federal adjusted gross income in calculating the New York
adjusted gross income. The interest earned receives tax-exempt treatment for NYS purposes and should
receive deferred tax treatment for federal income tax purposes, thus taxed when used. The account must
have been open for at least three calendar years before a qualified withdrawal can be made. Nonqualified withdrawals are subject to a NYS income tax and a 10% penalty. Investment income is subject
to federal income tax on the investment income. Contributions to all accounts for any beneficiary on
subject to a lifetime maximum of $100,000.
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Standard Deductions and Exemptions
2000
Standard Deduction
Tax Status:
Joint/(surviving spouse)
$13,000
Head of household
$10,500
Single
$7,500
Married filing separately
$6,500
Dependent filers
$3,000
Exemption
$1,000
Married persons filing separately each will receive one-half of the joint standard deduction. A New
York State exemption is not counted for either the filer or the spouse.
Itemized Deductions
Taxpayers, who file joint federal returns and separate N.Y. returns, must divide itemized
deductions between them as if their federal taxable incomes had been determined separately. Taxpayers
who do not itemize deductions on their federal returns may not itemize on their NYS returns.
Itemized deductions of higher-income taxpayers are subject to limitations and are reduced by the
sum of two percentages. The first percentage becomes effective at NYAGI levels dependent on the
taxpayer’s filing status, and the second becomes effective at NYAGI levels above $475,000.
1.
The first percentage is 25% of a ratio, which depends on the taxpayer’s filing status:
Numerator = Lesser of $50,000 or the excess
Filing Status
of NYAGI over:
Denominator
Married filing jointly
$200,000
$50,000
Single and married filing separately
$100,000
$50,000
Head of household
$150,000
$50,000
Example of first percentage (married, joint return): NYAGI = $225,000
$25,000 ÷ $50,000 = .5; .5 x 25% = 12.5% reduction in itemized deductions.
This taxpayer would not be subject to the second percentage because AGI is less than $475,000.
2.
The second percentage is 25% of a ratio, the numerator of which is the lesser of $50,000 or the
excess of NYAGI over $475,000 and the denominator of which is $50,000.
Example of second percentage: NYAGI = $550,000
$550,000 - $475,000 = $75,000; $50,000 is lesser.
$50,000 ÷ $50,000 = 1.0; 1.0 x 25% = 25% reduction
This taxpayer would also be subject to the full 25% from the first calculation so the total reduction
in itemized deductions would be 50%.
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Supplemental Tax for Taxpayers with NYAGI Exceeding $100,000
Taxpayers with New York adjusted gross incomes exceeding $100,000 pay a special tax computed
on a worksheet. The purpose of this tax is to remove the benefits of the lower tax brackets (the "tax
table benefit"). Between NYAGI of $100,000 to $150,000, the benefits of the rates below the top rate
are completely phased out.
Example: New and York Taxpayers have a NY taxable income of $105,000 and a NYAGI of
$120,000. Tax on $105,000 from the tax table is $6,399.00, but at the top rate of 6.85% is $7,192.50.
The $20,000 that exceeds the NYAGI level of $100,000 is 40% of $50,000. The difference between
$7,192.50 and $6,399.00 is $793.50; 40% of this is $317.40, which is added to the tax computed from
the table to make the total tax $6,716.40.
Spousal IRAs Allowed
A spousal IRA deduction claimed on a joint federal return is allowed on the NY return. If separate
returns are filed, each spouse’s deduction must equal the amount contributed to his or her own account.
Rates
There are three separate rate tables for (1) married filing jointly and qualifying widow(er), (2)
single, married filing separately, and estates and trusts and (3) head of household. Filing status
conforms to federal status except that when the New York resident status of spouses differs, separate
returns must be filed.
NYS Personal Income tax if the 2000 New York taxable income and filing status is:
Married Filing Jointly and Qualifying Widow(er)
Over
$ 0
16,000
22,000
26,000
40,000
Not Over
$16,000
22,000
26,000
40,000
Tax
4.00% of the excess over
$ 640 plus 4.50% " " " "
910 plus 5.25% " " " "
1,120 plus 5.90% " " " "
1,946 plus 6.85% " " " "
$ 0
16,000
22,000
26,000
40,000
Single, Married Filing Separately and Estates and Trusts
Over
$ 0
8,000
11,000
13,000
20,000
Not Over
$ 8,000
11,000
13,000
20,000
Tax
4.00% of the excess over
$ 320 plus 4.50% " " " "
455 plus 5.25% " " " "
560 plus 5.90% " " " "
973 plus 6.85% " " " "
$ 0
8,000
11,000
13,000
20,000
Tax
4.00% of the excess over
$ 440 plus 4.50% " " " "
620 plus 5.25% " " " "
725 plus 5.90% " " " "
1,492 plus 6.85% " " " "
$ 0
11,000
15,000
17,000
30,000
Head of Household
Over
$ 0
11,000
15,000
17,000
30,000
70
Not Over
$ 11,000
15,000
17,000
30,000
Household Credit
Single taxpayers with household gross income (HGI) up to $28,000 and all other taxpayers with
income up to $32,000 qualify for a household credit providing they cannot be claimed as a dependent on
another taxpayer’s return. Household gross income is federal adjusted gross income (total for both
spouses if filing separately).
In 2000, the amount of household credit for single taxpayers ranges from $75 (taxpayers with less
than $5,000 of HGI) to $20 for taxpayers with $25,000 to $28,000 of HGI. A separate schedule allows
more credit for married taxpayers, head of household, and surviving spouse, plus additional credit ($5 to
$15) for additional exemptions. The maximum credit for a married couple (filing jointly) with less than
$5,000 of HGI is $90 plus $15 for each personal exemption less one.
Earned Income Tax Credit (NY EIC)
An earned income credit is allowed against New York personal income tax. The NY EIC is 22.5%
of the federal EIC for taxable years beginning in 2000 (increasing to 25% in tax years thereafter)
However, the credit percentage may return to the 20% rate if the federal government takes certain
actions related to funds used to support the increase in EIC. The EIC must be reduced by the taxpayer’s
household credit. Therefore, a taxpayer will not receive the benefits of both the NY EIC and the
household credit.
Credit for Child and Dependent Care (CDC)
For tax years beginning in 2000, taxpayers with NYAGI of $25,000 or less will be allowed a NY
CDC credit of 110% of the federal child and dependent care credit. This refundable credit is gradually
phased down from 110% to 20% of the federal CDC credit for taxpayers with NYAGIs between
$25,000 and $65,000. At $65,000 and over NYAGI the rate remains at 20% of the federal credit.
However, these increased percentage will return to 1999 applicable percentage if the federal government
takes certain actions related to funds used to support the increase in the child care credit.
Real Property Tax Credit
The tax credit computations and limits are shown below for 2000. Few farm or nonfarm real estate
owners will qualify. Owners of real property valued in excess of $85,000 are excluded. Here are other
rules and limitations:
1. The household gross income limit is $18,000.
2. The maximum adjusted rent is an average of $450 a month, excluding utilities. The taxpayer must
occupy the same residence for six months or more to claim rent paid to qualify for the credit. Credit
for renters is computed the same as for owners.
3. Real property tax credit is the lesser of the maximum credit or 50% of excess real property taxes.
Taxpayers age 65 and older who elect to include the exempt amount of real property taxes will
receive no more than 25% of excess real property taxes. Excess real property taxes are computed by
multiplying household gross income times the applicable percentage and deducting the answer from
real property taxes. This tax credit is reduced by any other personal income tax credit to which the
taxpayer is entitled.
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Partial Table for Computing Real Property Tax Credit, 2000
Household Gross Income
$0 - $ 3,000
3,001 - 5,000
5,001 - 7,000
7,001 - 9,000
9,001 - 11,000
11,001 - 14,000
14,001 - 18,000
Applicable Rate
0.035
0.040
0.045
0.050
0.055
0.060
0.065
Credit Allowed
Under 65
65 & Over
$75-71
$375-341
69-67
324-307
65-63
290-273
61-59
256-239
57-55
222-205
53-49
188-154
47-41
137- 86
New York State Investment Credit (NYIC)
The credit for individuals is 4% on qualified tangible personal property (and other tangible property
used in production, including buildings and structural components) acquired, constructed, reconstructed
or erected on or after January 1, 1987. For corporations, the rate is 5% on the first $350,000,000 of investment credit base and 4% on any excess.
MACRS property placed in service after December 31, 1986 qualifies for NYIC. This means that
farm property in the ACRS or MACRS 3-year class should qualify. There is no reduction in the amount
of credit allowed for 3-year property, and if kept in use for three years it will earn 4% NYIC. Highway
use motor vehicles are ineligible for NYIC.
All ACRS and MACRS property that qualifies for NYIC and is placed in a 5-year or longer life
class earns full credit after 5 years even if a longer straight line option is elected. The same is true of 7,
10, 15, and 20-year MACRS property. Non-ACRS/MACRS properties that qualify for NYIC must still
be held 12 years.
Excess or unused credit may be carried over to future tax years but the carryforward period is
limited to 10 years. In no event may the credit claimed prior to 1990 be carried over to taxable years
beginning on or after 2000. The 1997 bill expanded general business corporations carry forward period
for unused investment tax credits from 10 to 15 years. There is no provision for carryback of NYIC.
Unused NYIC claimed by a new business is refundable. The election to claim a refund of unused credit
can be made only once in one of the first four years. A business is new during its first four years in New
York State. Only proprietorships and partnerships qualify. This refundable credit is not an additional
credit for new businesses. A business that is substantially similar in operation and ownership to another
business that has operated in the state will not qualify.
If property on which the NYIC was taken is disposed of or removed from qualified use before its
useful life or specified holding period ends, the difference between the credit taken and the credit
allowed for actual use must be added to the taxpayer’s tax liability in the year of disposition. However,
there is no recapture once the property has been in qualified use for 12 consecutive years.
Use IT-212 to claim New York investment credit, retail enterprise credit and to report early
disposition of qualified property.
Employment incentive tax credit (EITC) is available to regular corporations that qualify for NYIC
and increase employees at least 1% during the year. The credit is 1.5% of the investment credit base if
the employment increases less than 2%, 2% if the increase is between 2 and 3%, and 2.5% if the
increase is 3% or more for each of the two years following the taxable year in which NYIC was allowed.
The additional credit is available to newly formed as well as continuing corporations. The credit may
72
not be used to reduce tax to less than the minimum taxable income base or the fixed dollar minimum,
whichever is higher. Any remaining unused credit may be carried forward to the next seven taxable
years.
The employment incentive credit and economic development zone credit that applies to C
corporations was expanded to sole proprietorship, partners of partnerships, shareholders of S
corporations and beneficiaries of estates and trusts. The credits are available to those entities that make
investments eligible for the investment tax credit and in the years following the investment increase their
employee numbers.
Rehabilitation Credit for Historic Barns
NY Taxpayers are allowed a credit (as defined in IRC Sec. 47) of 25% of their qualified
rehabilitation expenses to restore barns originally constructed on or before 1936. The New York State
requirements for this credit follow the federal regulations, which were covered earlier in this workbook.
For newly constructed or reconstructed agricultural structures, New York’s real property tax law
Sec. 483 allows a 10-year property tax exemption from any increase in the property’s assessed value
resulting from the improvement. See the local assessor or board of assessors to determine eligibility and
file an application for exemption. In addition, for those rehabilitated historic barns, which do not qualify
for the 10-year exemption, there is a district exemption that requires the approval of the local taxing
authorities and school district. Again contact the local assessor for qualification rules and application.
The owner cannot receive both the 10-year exemption and this new assessment reduction.
Other Credits
Other New York personal income tax credits include resident credit for income taxes paid to other
states, accumulation distribution credit, economic development zone, and zone equivalent area wage tax
credit, qualified emerging technology company employment credit and emerging technology company
capital credit. For the latter two see tax law sections 606(i), (q), (d).
New York State Minimum Tax
Federal items of tax preference after New York modifications and deductions are subject to the
New York State minimum tax rate of 6%. The specific deduction is $5,000 ($2,500 for a married
taxpayer filing separately). A farmer who has over $5,000 of preference items must complete Form IT–
220 but may not be subject to minimum tax. New York personal income tax (less credits) and carryover of net operating losses are used to reduce minimum taxable income. NYIC cannot be used to
reduce the minimum income tax.
New York State SingleFile
NYS Department of Taxation and Finance and Department of Labor jointly developed a SingleFile
program to simplify reporting requirements for employers. It combines: Quarterly Unemployment
Insurance Report (Form IA-5) and Quarterly Combined Withholding and Wage Return Reporting (Form
NYS-4), enabling employers and their agents to report state withholding tax, wage reporting and
unemployment information on a single form. The form is NYS-45 and NYS-45-ATT in place of IA-5,
NYS-4 and NYS-4-ATT.
The filing and payment rules for making withholding tax payment have not changed. For further
details see NYS-50 available on the New York website. (www.tax.state.ny.us)
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New Hire Reporting
To facilitate the accurate and prompt determination of child support obligations, Chapter 81 of the
law requires all employers to report to New York State Department of Taxation and Finance identifying
information about each newly hired or rehired employee in New York State. Employers have 20
calendar days from the hiring date to provide the employee and employer name, address, and ID
numbers. (see NYS Notice 97-10)
Estimated Tax Rules
For tax years beginning on and after January 1, 1999 New York residents with New York source
income are required to make payments of estimated tax if they expect to owe, after withholding and
credits, at least $300 of New York tax (per jurisdiction) and withholding and credits are expected to be
less than the smaller of (1) 90% of the tax for the year, or (2) 100% of the tax on the prior year’s return
(provided a return was filed and the taxable year consisted of 12 months).
For individuals, estates and trusts (except farmers and fishermen) whose New York adjusted gross
income in the prior year is more than $150,000 ($75,000 if married filing separately) they must pay
110% of the prior year’s state, and if applicable, city resident or nonresident tax, or 90% of the current
year’s tax, to avoid a penalty for underpayment of estimated tax.
Farmers and fishermen may use the preceding year’s tax as a method of determining the required
annual payment without regard to the above limitation. The definition of farmers and fishermen for
estimated tax purposes was changed so that Federal Gross Income rather than New York Adjusted Gross
Income is used in determining whether at least two-thirds of the person’s income is from farming.
State Taxation of Non-Residents
In January 1996, federal law banned the taxation by states of payouts from qualified pension, profit
sharing, 401(k) or government plans and IRA’s, if the taxpayer was a non-resident. Income from nonqualified deferred-payment plans can be taxed by states unless payouts are made as a life annuity, for a
10-year or greater span or the distributions are non-qualified excess-benefits plans.
Effective on or after October 1, 2000 NYS lottery winnings over $5,000 are included within the
definition of NY Source income of a non-resident. Consequently, they will be subject to NYS tax on
payments in excess of $5,000 won in NY State and subject to withholding.
Estate Change
The modification for different New York and federal basis in property that is acquired from a
decedent dying on and after February 1, 2000 is repealed. The difference occurs if the estate was not
required to file a federal estate tax return but was required to file a New York estate tax return, and used
alternate or special valuation on the return. (Tax Law Sect. 612(r))
This publication is distributed with the understanding that the authors, publisher and distributor are not
rendering legal, accounting, IRS or other professional advice or opinions on specific facts or matters,
and, accordingly, assume no liability whatsoever in connection with its use or future rulings which may
effect the material presented. The information provided is for educational purposes only and nothing
here in constitutes the provision of legal advice or services.
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